Starwood Property Trust Stock: Strong 9% Return with Upside Potential (NYSE:STWD)

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There are many high-performance options on the market today, however, it pays to be choosy. On the one hand, investors should consider those stocks that have a long dividend history and an experienced management team. The pandemic of the last 2 years has provided an excellent litmus test for those companies that are built to withstand adversity, while maintaining a strong income stream for their investors.

This brings me to Starwood Property Trust (New York Stock Exchange:STWD), which passes this test. STWD remains attractively priced despite the recent market rally. In this article, I highlight why income investors should consider this stock, so let’s get started.

Why STWD?

Starwood Property Trust was founded more than 30 years ago and is led by Barry Sternlicht, longtime CEO and Chairman, who has been in the real estate business for decades. Since its founding, STWD has deployed more than $90 billion in capital and currently manages a portfolio of $27.5 billion in total assets.

Unlike pure-play commercial mortgage REITs, such as Blackstone Mortgage Trust (BXMT), STWD has a diverse set of assets that also includes residential and infrastructure loans, and ownership in physical real estate, such as equity REITs. Notably, STWD’s infrastructure portfolio is made up of $2.5 billion in energy-related assets.

As shown below, the infrastructure portfolio is well diversified by geography, with healthy exposure to the more stable midstream and downstream segments, as well as cleaner energy sources such as thermal and natural gas.

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STWD infrastructure portfolio (Presentation for investors)

However, commercial loans remain STWD’s bread and butter, accounting for 60% of its investment portfolio, with $16.4 in total assets. This portfolio is conservatively composed, with a weighted average loan-to-value ratio of 61%. This means that borrowers have a significant stake in the game, which helps reduce the chances of a total default. The commercial loan portfolio is also well diversified, with the multifamily segment being the largest (34% of the portfolio), followed by offices (23%), hotel (17%) and mixed use (9%).

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Meanwhile, STWD just completed a staggering $1.3 billion in investment activity during the third quarter, $900 million of which was in business loans. It also managed to increase its undepreciated book value by $0.18 from the second quarter to $21.69, and has plenty of balance capacity. This is reflected in STWD’s modest debt-to-equity ratio of 2.4xy with available liquidity of $1.3bn.

Also encouraging, the majority of new loan commitments (92%) are senior secured first mortgage loans and have a floating rate of 99%, helping to ensure that STWD captures the upside with the expectation of continued increases in the Federal Reserve rate, albeit potentially at a slower pace. pace given the somewhat lower rate of inflation in October.

Management highlighted the potential benefit of continued rate increases, as well as the strength of its platform in recovering principal on non-performing loans during the recent conference call:

Our earnings continue to be positively correlated with rising interest rates. This is the first quarter in which base interest rates exceeded 100% of our minimums, resulting in a $14 million increase in net interest income from higher base rates, which was offset by the benefit from our lows last quarter and higher interest expense due to timing. of debt withdrawals this quarter.

Companywide, including floating rate assets and liabilities across all of our business lines, a 100 basis point increase in base rates would increase annual earnings by $42 million or $0.13 per share. Since the end of the quarter, the one-month SOFR has already increased 76 basis points.

With respect to our three existing non-performing loans, we continue to use the breadth and experience of the Starwood platform to actively work toward full payment of the $465 million currently outstanding. We are confident in the underlying real estate and ultimately believe that these loans are fully recoverable. The $348 million of principal that we have invested in these loans would add significantly to our earning power once we are able to resolve them and reinvest the funds.

Furthermore, STWD yields an attractive 9.0% at the current price of $21.23 and the dividend is well distributed by EPS of $0.51 during the third quarter, resulting in a payout rate of 94%. STWD is also attractively valued today, trading at 0.98x unapreciated book value. Sell-side analysts have a strong buy rating on the stock with an average price target of $25.19, which translates to a potential total return of 28%, including dividends.

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Investor Takeaway

STWD is a high-yield, comprehensive commercial real estate lender that is performing well in the current environment and positioned to benefit from rising rates. It has just completed a wave of investments of 1,300 million dollars during the third quarter. It has ample liquidity, a conservatively managed loan portfolio, and pays a covered dividend yielding 9.0%. Lastly, I see value in the stock for income investors as it is still trading at a discount to unapreciated book value.

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