After the crazy equity shopping spree that I had in May, June has been comparatively pretty quiet thus far. I’ve been saving up some money both for my emergency fund and for my “house fund”, since I am currently in the process of becoming a homeowner. With that being said, however, it would be blasphemy of me to let an entire month go by without a single stock purchase. I have to diligently keep my financial snowball growing on a monthly basis if I am to achieve my goals of early financial independence.
There were a couple of REITs that I’ve had my sights set on for a while now that took a juicy dip in price over the last few weeks, most notably of which were Realty Income and Starwood Property Trust. And after some consideration, I decided on the latter. On 6/17/2015 I purchased 44 shares of Starwood Property Trust at $22.5/share, for a total investment of $990.00.
When deciding whether or not to buy a stock, I perform both a qualitative and quantitative analysis. Let’s start by looking at an overview of Starwood Property Trust, as stated on Yahoo Finance:
“Starwood Property Trust, Inc. originates, acquires, finances, and manages commercial mortgage loans, other commercial real estate debt investments, commercial mortgage-backed securities, and other commercial real estate-related debt investments in the United States and Europe. It operates in two segments, Real Estate Lending, and Real Estate Investing and Servicing. The company qualifies as a real estate investment trust for federal income tax purposes and would not be subject to federal corporate income taxes, if it distributes at least 90% of its taxable income to its stockholders. Starwood Property Trust, Inc. was founded in 2009 and is headquartered in Greenwich, Connecticut.”
One of the cool things about Starwood is that it operates through two segments: real estate lending (i.e. lending segment), and real estate investing and servicing (i.e. investing segment). This means that unlike many other REITs, Starwood isn’t as sensitive to rising interest rates, since rising rates actually bolster its lending segment. This blend of lending and investing gives the company’s segments a sort of system of checks and balances, ensuring that the business’s profits are only moderately affected by both high and low interest environments.
Starwood Property trust is actually the nation’s largest commercial mortgage REIT, with a market capitalization of over $5.3 billion. It is managed by Starwood Capital Group, one of the world’s largest and most successful private investment firms focused on real estate, which was founded and is headed by none other than brilliant, billionaire real estate tycoon Barry Sternlicht. Sternlicht is also the founder of the luxury “W Hotels” chain, which are pretty freaking drool-worthy.
All in all, you can’t go wrong with Starwood Property Trust if you are looking to invest in commercial real estate alongside one of the most successful and most brilliant minds in the field.
All the data I use to calculate stuff for my quantitative analysis is pulled from Morningstar. So without further ado, let us now take a look at some of the numbers and ratios behind Starwood Property Trust.
When looking at a company’s revenue growth, I like to compute the compound annual growth rate over 10-year, 5-year, and 3-year periods. This allows me to see whether or not the business has been growing over time and it also shows me whether the growth has been accelerating or decelerating in recent years. However, since Starwood Property Trust was founded in 2009, there is only enough data to compute 5-year and 3-year growth rates. So let’s take a look at the numbers:
This is some decent growth. And by “decent growth” I mean “holy ******* shit this is crazy growth”. With the U.S. economy back on track since 2009, commercial real estate transactions have continually increased every year, and Starwood Property Trust has evidently capitalized on this. That’s one of the awesome things about commercial real estate as opposed to residential real estate: it is very GDP-sensitive, which means that in times of economic upturn, it can yield some truly juicy returns. And who doesn’t like juicy returns?
Now, one thing to keep in mind is that REITs can’t be accurately assessed with the same traditional metrics used to analyze stocks. For example, most businesses include depreciation expenses as part of their net income calculation, which are totally valid non-cash charges to allocate for material crap that loses value over time as its useful life dwindles. In the case of real estate, however, since properties rarely lose value and usually actually appreciate over time, it makes sense to add depreciation and amortization back into the net income for the purposes of assessing performance. Gains or losses on the sale of properties are also adjusted in an REIT’s net income calculation, since these are profits and expenses that aren’t recurring and therefore don’t contribute to the REIT’s ability to pay dividends (since REITs are legally obligated to pay 90% of their taxable income to shareholders in the form of dividends and cupcakes).
Anyway, this adjusted net income for REITs is called Funds From Operations, or FFO for short. This number can be tricky to find online because many websites (Morningstar included) don’t provide it. You could of course calculate it yourself by looking at the REIT’s statements and annual reports, but I am way too lazy to do that. Luckily, the wall street journal is one site that does provide FFO numbers, so that’s what I used. Let’s look at Starwood’s FFO CAGRs:
Ok, so while these numbers aren’t quite as spectacular as the revenue growth ones, they are still pretty dang astounding. Certainly astounding enough to get me wet (TMI I know). All jokes aside though, I really like what I’m seeing here. While I don’t expect this kind of growth to last forever, so long as the economy continues to boom things should bode well for Starwood. Remember, a prosperous economy means more construction projects, more construction projects means more commercial real estate, more commercial real estate means more business for Starwood, and more business for Starwood means a fatter wallet for me 😎
As you can expect, in the same way that FFO is a more accurate metric than net income for assessing an REIT’s performance, so is FFOPS as opposed to the traditional EPS metric. Check out Starwood’s FFO per share CAGRs:
These are some really solid numbers, and it looks like Starwood has been very consistently increasing its FFOPS at an annual rate of 11% since both the 5-year and 3-year figures are nearly identical. I find that FFO numbers on a per-share basis are even more indicative of an REIT’s performance than just FFO, since REITs are notorious for increasing their share counts a lot over time. For instance, Starwood’s shares outstanding increased from 48 million in 2009 to 215 million in 2014. That’s a 216% increase in shares outstanding in 5 years, lol. So yeah, FFOPS is the way to go, in my opinion, and numbers in the high single-digits/low double-digits are fantastic, especially if maintained over time.
Return On Equity
I like to look at a company’s return on equity to get an idea of how much profit it generates with the money that shareholders invest in it. A really low ratio can be synonymous with low profitability and begs the question of what the hell the company is doing with our cash.
Star Wars Property Trust boasted a nice ROE of 12.16 in 2014, which is leagues above the industry average of 3.8. This speaks to the awesomeness of this REIT! #win
The debt-to-equity ratio will tell you if a company has been using a lot of leverage to finance its growth. Acceptable numbers here will vary depending on the industry you’re dealing with, with some sectors like the financials sector being notorious for their high levels of debt. Starwood’s debt-to-equity ratio clocked in at a minuscule 0.37 in 2014, well below the industry average of 1.2. More #win.
Interest Coverage Ratio
Another important ratio I like to look at is the interest coverage ratio, which you get by dividing a company’s earnings (before taxes, interest, rainbows, etc.) by its interest expenses. I usually like to see a number above 5 here, preferably even 10, though again this can vary significantly depending on the industry we’re dealing with (with REITs being an example of an “industry” where lower numbers are common and normal).
Starwood had an interest coverage ratio of 4.34 in late 2014, which is excellent for an REIT. Given this number and the low debt-to-equity ratio, it is clear that the company is led by a strong management team that is adept at managing the business’s debts and liabilities. Even more #win!
The company’s yield currently hovers in the neighborhood of 8.5%, which is reaaaaaaaaaaally meaty, even for an REIT. I always try not to get caught in the fallacy of chasing high yields, so when I do find a company that sports a huge yield without any sketchy financials to back it up, I get really excited. In fact, I’m so excited that I will share a picture of my incredibly cute and fluffy cat with you guys:
Starwood’s payout ratio sat at 81.7% in 2014, which is high but normal given the REIT’s legal obligation to pay the bulk of its earnings to shareholders.
Dividend Growth Rate
Dividend growth rate is one of the most important factors to look at as a dividend investor. Here are Starwood’s 5-year and 3-year DGRs:
At first glance these are some completely incoherent numbers, haha. However, the dramatic difference between the two is easily explained by the fact that in 2009 (the company’s year of inception), the dividend was but a mere $0.11, before increasing to $1.20 in 2010, $1.74 in 2011, $1.76 in 2012, $1.82 in 2013, and $1.92 in 2014. So the 5-year CAGR is totally off and absolutely not representative of the company’s actual dividend growth rate (don’t I wish!). The 3-year figure gives us the real picture, and while the growth rate is pretty low even for an REIT, this is normal given the company’s massive yield. If Starwood can maintain its DGR in the 3%-5% range while keeping its yield above 7%, I’ll be more than happy.
I used a DDM (Dividend Discount Model) with a discount rate of 12% and a dividend growth rate of 3% to valuate the stock.
Using these numbers, the fair value came out to $21.97, which means that I purchased the stock at a small premium. Seeing as it had been selling between $23 and $25 for the past like, 3 years though, I was more than happy to initiate a position for under $23. This is an REIT that I definitely plan on accruing more shares of as time goes by, as it generates a huge amount of passive income for my portfolio with its gigantic yield.
This was my first and probably only purchase for the month of June, but I am very happy with it. Even though the dividends I receive from Starwood Property Trust won’t qualify for any special tax treatment since REIT dividends are considered to be ordinary income, the huge yield more than makes up for it. Starwood is now tied with Chevron as my portfolio’s largest passive income provider, each bringing in around $85/year in dividends. And since Starwood’s ex-dividend date isn’t until June 26th, I’ll be receiving my first payout from them next month. I’m looking forward to it!
Thanks for reading and being an awesome, sexy reader.
What’s your opinion of STWD? Has it been on your radar as of late? What other REITs are you looking at these days?
Disclosure: long STWD