A number of stocks fell back into high value ranges after this month’s selloff, bringing yields back to levels last seen in late September. This includes Starwood Property Trust (NYSE: STWD), which now pays 10.5% after the recent sale. As shown below, STWD is now trading just ahead of its 52-week low, and in this article, I highlight why now is the time to layer on this high-yielding stock.
Starwood Property Trust was founded over 30 years ago and is led by longtime CEO and Chairman Barry Sternlicht, who has worked in the real estate industry for decades. Since inception, STWD has deployed over $90 billion in capital and currently manages a portfolio of $27.5 billion in total assets.
What sets STWD apart from its commercial mortgage counterparts is its diverse set of assets which, beyond commercial loans, include physical real estate and residential and infrastructure loans. This multi-cylinder approach helps insulate STWD from weakness in any given area, and physical and infrastructure loans are generally more stable given the longer lease terms (compared to commercial loans) and the durability of the underlying asset class.
To get an idea of how cheap STWD has gotten lately, at the current price of $18.33 STWD is now trading well below its 200 and 50 day moving averages of $20.86 and 19, $64. I do see potential for support at the $18 level though, given that it last tested those levels in late September and early October before moving higher.
Also, as with the selloff in September, some of the selling this month could be attributed to portfolio dressing by hedge funds, exacerbated by the harvest of year-end tax losses. If so, then STWD could see an upward mobility pattern as it saw at the start of the fourth quarter.
Of course, there is a lot of guesswork involved in technical analysis, and STWD could see a further downturn if the market remains bearish through 2023. Such downturns can and do happen, as was the case for the market in January 2016, when stocks sold off before staging a rally in February of that year.
Nevertheless, STWD remains a good standard, as the experienced management team has proven adept at managing risk. This is reflected in the average loan-to-value ratio of the commercial loan portfolio of 61%, implying that borrowers have an important role to play. Additionally, unlike some peers who have a higher exposure to offices, STWD’s largest segment is multifamily, which accounts for 34% of the loan portfolio, followed by office at 23%, hotel at 17% and mixed use at 9%.
Additionally, first mortgages make up the vast majority (92%) of STWD’s commercial loan portfolio, and STWD is reasonably leveraged for a commercial mortgage REIT, with a leverage ratio of 2.4x and a credit rating of BB+ credit. It also has 1.7x interest coverage and maintains substantial liquidity of $1.3 billion.
Additionally, 99% of STWD’s loans are variable rate, which positions it to capitalize on higher interest rates, especially as the market widely expects another rate hike next year. Federal Reserve meeting next month, following the 50 basis point hike in December. Management emphasized how correlated earnings are with rising rates on the last conference call:
Our earnings continue to be positively correlated to rising interest rates. This is the first quarter where base interest rates exceeded 100% of our floors, resulting in a $14 million increase in net interest income due to higher base rates, which was offset by the benefit of our floors last quarter and higher debt timing interest charges this quarter.
Company-wide, including floating rate assets and liabilities across all of our businesses, 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 by 76 basis points.
Importantly, STWD’s quarterly dividend of $0.48 is protected by a coverage ratio of 106%, based on distributable earnings per share of $0.51 during the third quarter.
Notably, STWD’s unamortized book value increased by $0.18 last quarter to $21.69. This translates to an unamortized price-to-book value ratio of just 84.5%, based on the current stock price of $18.33. In other words, buyers get a 16% discount off today’s prices. Analysts have a Strong Buy consensus rating with an average price target of $24.44, which equates to potentially very strong total returns from here.
Key takeaway for investors
STWD has sold off strongly this month and is approaching its 52-week lows again. However, recent market volatility offers value investors an opportunity to acquire this quality commercial mortgage REIT security at a discount. STWD’s strong management team and portfolio positioning should enable it to take advantage of rising interest rates in the coming months.
Certainly, no commercial mortgage REIT is a “sleep well at night stock”. However, I find STWD’s current valuation to be attractive and the 10.5% yield very attractive for a well-diversified portfolio.