Starwood Property Trust Should Benefit From Rate Cuts And 9.64% Yield (NYSE:STWD)

I was a shareholder in Starwood Property Trust (NYSE:STWD) since late 2016 and has been an income investor’s dream. Regardless of what happened in the global economy, STWD produced a quarterly dividend of $0.48 like clockwork. Over the past decade, STWD stock decreased -13.41% or -$2.59 but shareholders received $19.20 in dividend income without considering the power of compound interest for those who reinvested the dividends. Despite going through recessions, a global pandemic, inflation and geopolitical tensions, STWD has traded relatively sideways for many investors while giving up reliable income over the years. I am bullish on STWD moving toward rate cuts, as a declining rate environment should benefit the companies that STWD has made loans to, while reducing some of the interest expense that STWD bears. We could also see that STWD’s book value extends over next year, which could help the stock appreciate in value. I believe STWD is well-positioned after navigating a difficult operating environment for REITs and can continue to generate a high single-digit return for investors.

Following is my previous article on STWD

I previously wrote an article about STWD in May after their Q1 2024 earnings were reported (read here). Since then, STWD shares are down -0.83%, while the S&P 500 is up 7.51%. When factoring in the dividend, STWD’s total return over the period is 1.71%. We discussed why I was bullish on STWD after the earnings, how the dividend benefited my investment in STWD, and why I needed the rate cut environment to get started. I follow up with a new article heading into the Fed meeting as all signs point to a rate cut in September. I’ll discuss how additional economic data makes me more bullish on STWD and how dividend reinvestment should impact my future dividend income.

Risks of investing in STWD

While I’m bullish on STWD, that doesn’t mean this investment will work. If it weren’t for the dividend, STWD wouldn’t be all that interesting given that its share price has fallen over the past 5 years. My investment thesis on STWD revolves around the rising housing market and rate cuts. If the business environment becomes tougher rather than softer, then companies that STWD has lent money to could default or run into trouble. If the Fed doesn’t cut rates, then STWD’s borrowing costs won’t go down, and REITs could come under pressure again. Higher for a longer time could increase STWD’s debt level, which could reduce the level of capital allocated to the quarterly dividend. There is also the risk of a collapse in property valuations after rates fall as too much supply hits the market. If this happens, STWD’s carrying amount could be adversely affected. There are many reasons to be skeptical about investing in STWD, and investors should do their due diligence.

Share count and dividend income have doubled since STWD’s dividend reinvestment

It has been almost 8 years since I started my original position in STWD in late 2016. I have added to my total holdings in STWD over the years, but those purchases were made in other accounts. We originally bought 135 shares for $3,059.07 at an average price of $22.66 per share. I collected and reinvested 31 dividends along the way, which totaled $288.02 or 94.21% of my original investment. I now have 275.97 shares in this account because I purchased another 140.97 shares through dividend reinvestment. My share count grew organically by 104.42% and my annual dividend income grew as well. STWD has paid an annual dividend of $1.92 per share since I have been a shareholder. By reinvesting the dividends, my forward dividend income increased by $270.66 (104.42%) from $259.20 to $529.86. While STWD’s stock price has declined -10.86% since I started the position, my actual investment has risen 94.21%, representing an annualized return of 11.9%.

My quarterly dividend income has increased by 99.62% since Q1 2017. The average quarterly dividend growth over the last 31 dividends was 2.33% despite STWD not increasing its dividend payout. By reinvesting dividends, I buy more shares and organically grow my share count and future dividend payments each quarter. STWD is a position I do not intend to exit unless my investment thesis changes. When I extrapolate the current dividend history I’ve established to 2034, the dividend income I expect to generate will be significant compared to my initial investment. It has currently generated $2,882.02 in the last 31 dividends and will collect another 41 dividends until 2034. At an average quarterly growth rate of 2.33%, I expect to generate a dividend of $132.37 in Q4 of 2024, which will increase to $332.59 in Q4 2024. Over the next 41 dividends, I would expect to generate dividend income of around $8,925.65, which would bring the total dividend income that this their investment will be generated at $11,897.66. In the first 4 quarters of STWD’s debt, the investment generated dividend income of $267.58 and I project that it will generate $1,285.60 in 2034 as long as STWD maintains a dividend of $1.92 per share.

Since I started this position, my share count and forward dividend income have more than doubled. When I look at the chart below, the next decade of dividends is expected to rise on a steeper slope as the powers of capitalization take effect. There will always be a debate about opportunity cost versus indices when it comes to dividend investing. While I’m a big fan of index funds and have 100% of my 401k allocated to an S&P 500 index fund, in addition to having investments in several index funds outside of retirement accounts, I’m also a big believer in having a income generating portfolio. . By having many investments with different incomes, I can generate recurring income without having to sell shares of the investment. I am excited to see where my initial investment in STWD ends up by the time I retire, as I have many years to collect the dividends into a much larger dividend snowball than the chart below indicates. STWD has been a consistent dividend payer and I think my forward dividend income will look like the chart below.

Why a rate cut is likely this week and why I’m bullish on STWD

Crude oil is down and trading at $68.65 a barrel, after falling -24.57% over the past year from above $90 a barrel. I have said in many articles that inflation is likely to follow commodity markets because as commodity prices fall, so will input, energy and transportation costs. Just got the latest CPI print out and it has slowed to 2.5% which is the lowest level since February 2021. There is more of a reason to cut rates as the bond market has not reversed and the 10yr is yielding 3.66% , which signals that the Fed is offside. CME Group now odds on a 50/50 split ahead of September 18 Fed meeting^th whether Fed Chairman Powell will announce a 25 or 50 bps rate cut. Looking out to December 2025, CME Group projected that the most likely scenario will be for rates to be at 300 bps or lower. This is optimistic for many companies and industries, but I believe it will prove to be extremely beneficial for STWD.

STWD has drawn $14.96 billion on its financing facilities, and a rate cut cycle is positive for its balance sheet and real estate portfolio. If the Fed cuts rates in a manner similar to their dot chart trajectory, many REITs, including STWD, will benefit greatly. STWD invests in loans and commercial real estate, which puts it in a prime position to benefit from a change in monetary policy. Lower federal funds rates would reduce STWD’s interest expense, as there is nearly $15 million drawn from STWD’s financing facilities. Lower rates would correlate with lower costs for servicing their obligations. A lower rate environment going forward would set the stage for STWD to refinance existing loans at a lower rate, which would lower their interest expense and improve their margins. When rates fall, it becomes less expensive to borrow capital, and this could cause a reverse crash in the housing market as we could see increased activity in property purchases. If this occurs, it could increase the value of STWD’s properties and increase their book value. There are many benefits that STWD could realize over the next year or two as the Fed lowers rates, and I think STWD shareholders will benefit while receiving a large dividend that exceeds the risk-free rate of return.

While STWD missed consensus estimates for distributable EPS of $0.49, coming in at $0.48, it was still a good quarter for STWD. Over 40% of STWD’s assets are diversified outside of commercial lending as STWD has positioned itself for the future. STWD originated and acquired $925 million worth of assets across its business segments in Q2, while completing its third infrastructure CLO for $400 million. STWD sold and repaid $994 million of its bonds and revalued a $591 million term loan facility, which allowed them to narrow the rate spread by 50 bps from 325 to 275 .STWD management also revealed some interesting information about the property segment of their business. They estimate that if rents grow at 50% of the rate they have over the past 7 years and their expenses grow at 2% annually, then the portfolio will have about $800 million more over the next 8 years if the cap rate remain. same. There is a lot to be excited about and I think the lower rate environment will be very beneficial for STWD and its shareholders.

Conclusion

I think STWD will be a very attractive investment in a lower rate environment as investors look to recreate the risk-free rate of return they are used to generating. The Fed’s trajectory looks like rates will end in 2025 at around 300bps, which could create more catalysts for STWD. If STWD is able to increase its margins by reducing interest expense and refinancing its debt to favorable levels, we could see increased levels of profitability and the potential for dividend growth. We could also see STWD’s book value increase as its property value rises and its share price rises. I think STWD is well positioned for the next economic cycle and could provide investors with large amounts of income while generating some capital appreciation in its share price.