STWD - Starwood Is Up 20.92% From The Bottom And Looks Attractive Yielding 9.89%

2023-06-20 09:00:00 ET

Summary

• I discuss my positive experience investing in Starwood Property Trust, a real estate investment trust, which has provided stable high yield income for my portfolio.
• Despite a decline in share price, my investment in STWD has increased in value by 50.69% over 6.5 years, with an average annual return of 7.8%, thanks to the power of compounding and reinvesting dividends.
• I believe STWD is still an attractive income investment option, with a 9.89% dividend yield and potential for capital appreciation, while also highlighting the importance of understanding individual investment goals and strategies.

When it comes to investing, goals differ from person to person, and the same investment methodology that works for one person may not be the correct fit for another. I firmly believe that before allocating capital toward any investment, an individual should have a clear definition of what their desired outcome is. What works for me may not be applicable to someone else's situation. It's easy to sit back and play Monday morning quarterback and say if you had just invested in Apple ( AAPL ) you would have outperformed the market, or if you had invested in an index fund, you wouldn't be outperforming the market without having the context of what their objectives were, or financial situation is. I think one of the biggest things to remember when reading articles on Seeking Alpha is that everyone's situation is different, and it's perfectly fine to disagree with an article or someone's opinion, but it's critical to put everything in context.

Starwood Property Trust ( STWD ) was the first real estate investment trust ((REIT)) that I had invested in. I have different segments within my portfolio, and a portion of the capital I invest gets allocated toward income-producing investments. When I retire, I hope to have this segment pay for a significant portion of my monthly nut, if not all of it. I have different accounts for different investments, and I track my original investments in companies separately, so it's easier for me to keep track of the investment metrics. To some, what I am going to share won't be impressive; to others, it will sound great. For me, STWD continues to meet the criteria I need on the income side of my portfolio. STWD has bounced off the lows, appreciating by 20.92%, and I feel it's still an interesting income investment with more upside for investors with a focus on generating a higher-than-average yield that's stable.

How my initial investment in STWD has worked out

STWD was my first REIT investment, and I did an immense amount of research. The aspect that tipped the scale for STWD was Barry Sternlicht, their CEO. I had watched several interviews and fireside chats that he conducted, and his philosophy and management style resonated with me. I felt that this was a company that was well run, had strong assets, and could deliver stable high yield to the income side of my portfolio. This investment was never about capital appreciation, and while the share price has declined -14.17% since my initial investment was made, the overall value of this investment has increased by 50.69%. That's an average annual return of 7.8% over the past 6.5 years, with shares of the company declining -14.17%.

I had made an initial investment of just over $3k as my first REIT investment and purchased 135 shares of STWD. With an annual dividend of $1.92 , this was projected to generate $259.20 in annual dividend income, which was an 8.47% yield. Some individuals have told me to just throw my capital in an S&P 500 index fund and sell a share here and there when I want the income. For some, that may be a good idea, but for me, I am not interested in drawing down on my share base to generate income, I would rather have a section of my portfolio focused on producing income and have an asset base that is producing a steady stream of dividends without selling a portion of those positions as needed.

Over the past 6.5 years, my share count has increased by 75.56%, and my projected annual dividend income has also increased by 75.56%. By reinvesting each quarterly dividend, my projected annual dividend income has increased by $195.84 from $259.20 to $455.04. I have collected 26 quarterly dividends, and my investment of just over $3k has generated $2,266.07 in dividends or 74.08% of my original investment. My first quarterly dividend income has increased by 76.22% going from $64.80 to $114.19.

The power of compounding is real, and even though shares of STWD have seen better days, I am producing additional income each quarter from reinvesting the dividends, and my overall investment is larger than when it started. Some may be wondering what would have occurred if I had just taken the dividends as cash. If I had taken the investments as cash, my original investment would have declined by -14.17% or -$433.32, and I would have generated $1,684.80 in dividend income, with the original shares still producing $192 of annual income in $64.80 increments.

I currently have 26 quarters of data, and my average quarterly dividend increase has been 2.2%. I built a model below of what I can expect over the next decade if my average quarterly dividend increase from reinvesting the dividends continues to be 2.2% based on the current dividend of $1.92. Over the next decade, my quarterly dividend would theoretically increase by 139.27% ($159.03) from $114.19 to $273.22. I would have collected $9,637.38 in dividends from an investment of just over $3k without putting in an additional dollar, and I will still own the underlying asset of shares that will continue to grow over the next decade. When I take into consideration the additional investments I have made into STWD, obviously, the numbers increase, but from an income perspective, this is what my original investment has done and what it is projected to do based on the information I have.

Remember, just because allocating a portion of my capital toward income investments is suitable for me, it may not be for someone else, and I am not writing this to change anyone's mind. I think investing in an S&P 500 index fund is one of the best vehicles individuals have to create wealth.

Starwood has paid a solid dividend that hasn't been reduced throughout very difficult economic environments

STWD went public during the financial crisis and increased its quarterly dividend 7 consecutive times from Q4 2009 to Q2 2011. Throughout the financial crisis, STWD increased its dividend, and throughout the pandemic and a rising rate environment, STWD has maintained its dividend without a single reduction. This is a testament to management and business operations. As I illustrated in my examples above, when you're getting paid a high single or low double-digit yield, you don't need annual increases to benefit immensely from the powers of compounding. On the Q1 conference call , Barry Sternlicht indicated that they want to protect the dividend STWD pays at all costs, which gives me comfort in the model I created of what my quarterly dividend increases will look like over the next decade.

Despite the Fed pause, Fed chair Powell indicated in his speech that nearly all policymakers agree that further rate hikes will need to occur in 2023. He also hinted that rates may need to stay higher for longer. Nobody can know what the Fed will do, but rates will inevitably come down, when the cuts start is yet to be determined. Sure, people are able to lock in attractive rates on non-risk assets now, but what occurs when rates start to decline? Eventually, REITs such as STWD will look much more attractive as the Fed brings rates down into the 3% range, and you can no longer get 4-5% on non-risk assets. I think over the next 2 years, we will see money flowing from maturing non-risk assets that people were accustomed to getting 4-5% on to larger yielding risk assets to generate a larger than average yield for taking on risk. STWD will continue to build its track record and should be an attractive income vehicle for individuals coming out of risk-free assets.

Starwood still looks interesting even after the recent jump from the lows

Since I have been a shareholder, STWD has increased its book value by 17.20% from $17.44 to $20.44. Its tangible book value has also increased 21.18% from $16.05 to $19.45. Today shares of STWD trade at an exact 1:1 ratio compared to its tangible book value and at a -4.84% discount to its GAAP book value. At the end of Q1, STWD had an undepreciated book value of $321.37 and, per Share Bridge, a current FMV of $21.55. The fair market value is subjective and based on several economic factors, but if it is correct, then shares are currently trading at a -9.74% discount to this metric.

STWD is a well-diversified REIT with only 10% of its portfolio exposed to U.S. office. STWD finished Q1 with $28.5 billion of total assets with an adjusted debt-to-equity ratio of 2.5x. 87% of its outstanding debt contains no capital markets mark-to-market provision and ample capacity to fund future growth. STWD has $8.3 billion of capacity across secured financing facilities and $4.2B of unencumbered assets with capacity to issue over $1.0B of corporate debt. In addition to trading under book value, STWD has a market cap of $6.06 billion with $7.12 billion of total equity on the balance sheet, of which $6.38 billion is attributable to stockholder equity. From a valuation standpoint, STWD trades under book value, and its market cap trades at a discount to equity. Maybe this continues for some time, but eventually, when the macro environment improves, and the headlines change, this should reverse and create value for shareholders in the form of capital appreciation.

Conclusion

I have no interest in being a landlord or investing in physical real estate outside of my personal residence. For this reason, I invest in REITs on the income side of my portfolio. This provides exposure to real estate without having to deal with the headaches of being in the real estate business. STWD was the first REIT I invested in, and I plan on being an equity shareholder for decades to come unless something in my investment thesis changes. STWD looks undervalued compared to its book value, and it's still producing a 9.89% dividend. Since being a shareholder, my quarterly dividend payment has increased by 76.22% through the power of compounding, and as long as the dividend stays stagnant, I am expecting another 139.27% growth in my quarterly payments over the next decade. STWD is an income play for me that could generate some appreciation along the way, but I have been very happy with the income generated and have made additional investments in STWD along the way. Income investing isn't for everyone, but for those that are interested, I hope that the numbers I shared from my investment can provide a perspective on what is possible.

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