The yield of Starwood Property Trust Inc. (NYSE: STWD) is already attractive, but I’m going to double down on the mortgage trust when I get the chance. Last month, Starwood Property reported strong 1Q-22 earnings, and the trust’s real estate holdings provide a natural hedge against inflation.
Starwood Property also easily outperformed its dividend with distributable earnings in the first quarter, making STWD a very reliable dividend-paying trust going forward.
Despite record inflation rates, life is still good for real estate investors. Despite rising interest rates making financing and acquisition transactions more expensive for mortgage trusts, real estate has always been the best asset class to own in a rising interest rate environment. ‘inflation. In April, inflation reached 8.3% and is expected to remain high for some time.
Real estate has traditionally been a good hedge against inflation because as consumer prices rise, so do rents and property values. In my opinion, high-quality trusts such as Starwood Property, which also own real estate portfolios, are excellent investments during times of skyrocketing inflation.
Starwood Property Trust’s primary business is origination of mortgages, but the trust also has a property portfolio. In 1Q-22, the gross value of these properties was $2.2 billion. These properties were worth $1.4 billion on a net basis, that is, after taking into account financing agreements. Despite the fact that real estate investments represent only a minor part of Starwood Property’s business, the trust’s real estate assets have upside potential as inflation rises.
Stable distributable income, growth in commercial loans
Starwood Property earned $240 million, or $0.76 per share, in the first quarter, compared with $150.8 million, or $0.50 per share, in the same period last year. The trust’s distributable earnings per share for the last quarter included a gain of $0.27 per share from the sale of a distribution facility acquired in a foreclosure. Excluding the one-time gain, Starwood Property Trust generated distributable earnings of $0.49 per share, an important metric for assessing the safety of the trust’s dividends.
As noted earlier, commercial mortgages are Starwood Property’s primary source of revenue. As of March 31, 2022, the carrying value of these loans was $14.8 billion. During the pandemic, Starwood Property aggressively expanded its commercial business: From 1Q-20 to 1Q-22, assets included in commercial lending business grew 56%.
Today, 92% of loans are first mortgages, which are primary liens on real estate, the highest quality category of commercial loans because they are very likely to be repaid.
The loan-to-value ratio, or LTV ratio, determines the level of risk that a borrower or an investment portfolio of real estate assets faces: Starwood Property’s LTV ratio was 61% at the end of last quarter, which is a low ratio. The higher the LTV ratio, the less secure the repayment of the loan. When a recession looms and borrowers come under increasing financial stress, high LTV ratios are a problem.
The dividend is safe
I have no reservations about the Starwood Property dividend; it is extremely secure. Over the past year, the trust has consistently outperformed its dividend, and actual distributable earnings, as reported by the company, are even higher than the adjusted earnings shown below.
The adjusted distributable earnings line below corrects for one-time gains, such as the $0.27 per share gain noted above, which are sometimes included in Starwood Property earnings.
A low multiple
Due to the Trust’s large asset base, I value Starwood Property on a book value basis. The trust has a book value multiple of 1.16x, which is a very reasonable multiple for Starwood Property, given that the company pays its dividend and has seen strong growth during the pandemic. Blackstone Mortgage Trust Inc. (BXMT)for example, sells for a comparable multiple.
Why Starwood Property Trust shares could lose value
A sharp decline in the U.S. real estate market, particularly in multifamily real estate, where Starwood Property’s commercial lending is concentrated, could jeopardize the trust’s estimated credit losses as well as its income from real estate assets.
Starwood Property, on the other hand, has an excellent reputation which it has earned over time by making sound investment decisions and paying a consistent dividend. During the pandemic, the trust created and acquired real estate assets aggressively and countercyclically. That said, a recession remains a risk factor for Starwood Property’s valuation.
Starwood Property Trust is a mortgage trust that I buy on every dip. The trust’s $0.48 per share dividend is covered by distributable earnings, and management has doubled its commercial loan portfolio during the pandemic.
In the future, the real estate segment could benefit from inflation, which would cause the valuation of the trust’s assets to increase. The dividend is safe and the multiple of book value is fair.