Starwood Property Trust: Buy This Top-Shelf 8.6%-Yielding Commercial Mortgage REIT

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About: Starwood Property Trust, Inc. (STWD)
by: Achilles Research
Summary

Starwood Property Trust is a high-quality income vehicle for high-yield investors.

Starwood Property Trust recently reported strong results for its fourth quarter.

Starwood Property Trust easily covers its dividend with core earnings, and has NII upside potential.

Shares are moderately valued and have an attractive risk/reward.

An investment in STWD yields 8.6 percent.

Starwood Property Trust, Inc. (NYSE:STWD) is a high-quality income vehicle for investors that desire high, recurring dividend income from one of the best commercial mortgage real estate investment trusts in the sector. Starwood Property Trust easily outearns its dividend payout with core earnings and has considerable net interest income upside in a rising rate environment. The REIT's shares are moderately valued on a core earnings basis, and an investment in Starwood Property Trust yields 8.6 percent.

Starwood Property Trust - Portfolio Overview

Starwood Property Trust is a large commercial mortgage real estate investment trust with an equity value of $6.0 billion. The REIT primarily invests in first mortgage loans, subordinated mortgages, and mezzanine loans but also makes direct real estate investments. First mortgage loans accounted for the lion's share of Starwood Property Trust's core commercial investment portfolio, representing ~85 percent of portfolio value.

Here's a portfolio snapshot.

Source: Starwood Property Trust Investor Presentation

Starwood Property Trust's commercial portfolio is diversified geographically, but has nonetheless large exposure to cyclical real estate such as offices and hotel properties.

Source: Starwood Property Trust

Starwood Property Trust continued to originate new loans in the quarter ending December, setting the company up for net interest income growth in the coming quarters. The majority of new originations, 86 percent, were floating rate.

Source: Starwood Property Trust

Starwood Property Trust has considerable net interest income upside due to its large presence of floating rate loans in its investment portfolio. 93 percent of the commercial mortgage REIT's loan portfolio is linked to variable rates, meaning the higher short-term interest rates climb, the bigger the NII impact.

According to management, a one percent increase in interest rates is going to boost net interest income by $0.07/share annually going forward.

Source: Starwood Property Trust

Distribution Coverage

Starwood Property Trust is a high-quality income vehicle primarily because of its very good dividend coverage: The commercial mortgage REIT outearned its dividend in every single quarter in the last three years, meaning investors don't have to worry about dividend sustainability.

Starwood Property Trust earned an average of $0.54/share in core earnings in the last twelve quarters which compares favorably to a stable dividend rate of $0.48/share. The implied (average) core earnings payout ratio was 89 percent.

Source: Achilles Research

Though Starwood Property Trust is not growing its dividend payout, the covered 8.6 percent dividend yield is attractive.

Chart Data by YCharts

Valuation

Starwood Property Trust's shares are moderately valued based on run rate core earnings: The REIT earned $0.54/share in core earnings in Q4-2018, in line with its 3-year average, which means income investors wanting to secure STWD's healthy dividend pay ~10.3x Q4-2018 run rate core earnings.

In terms of price-to-book ratio, Starwood Property Trust sells for a premium to book value and has done so for a while.

Here's how Starwood Property Trust compares against its peers in the sector in terms of price-to-book ratio.

Chart Data by YCharts

Risk Factors Investors Need To Consider

Starwood Property Trust should be doing well as long as the U.S. commercial real estate market remains in shape and financing demand for new real estate projects remains high. On the flip side, a downturn in U.S. commercial real estate and/or a U.S. recession will likely impact Starwood Property Trust's origination volume negatively, which in turn could lead to a deterioration of the REIT's distribution coverage. Investors need to carefully monitor Starwood Property Trust's financial performance and dividend coverage stats going forward.

Your Takeaway

Starwood Property Trust makes a compelling value proposition for income investors seeking to access a high-quality, sustainable dividend: The REIT has a large floating-rate loan portfolio that can be expected to produce higher net interest income in a rising rate environment. Further, Starwood Property Trust has superb dividend coverage stats for an income vehicle with an almost 9 percent dividend yield. Shares are moderately valued and have an attractive risk/reward. Buy for income and capital appreciation.

Disclosure: I am/we are long STWD, LADR, BXMT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.