Looking at the state of the commercial real estate market in the wake of the global pandemic, it's understandable that Starwood Property Trust (NYSE: STWD), one of the largest mortgage real estate investment trusts (mREITs) in the commercial space, was bound to have been impacted negatively. But after an impressive rally from initial pandemic concerns, investors wonder where this mega giant mREIT may be headed in the future. Here's a closer look at Starwood Property Trust today and where the company could be in three years.
Starwood Property Trust today
Starwood Property Trust started in 2009 primarily as an originator and investor in commercial mortgages and mortgage-related securities. The company expanded its business model in 2016 and beyond, adding residential loans, infrastructure loans, and alternative securities to its portfolio holdings. As of May 2021, 64% of the company's portfolio was commercial lending, followed by 13% of real estate-owned property (REO), 10% in infrastructure loans, 8% in other real estate investment securities, and 5% in residential lending.
Starwood Property Trust is massive, with a market cap of $7.1 billion, offices on four continents, and $18 billion of assets under management in its current portfolio. Office and hotel investments make up 32% and 19%, respectively, of the company’s underlying assets, somewhat concerning given these sectors, in addition to retail, have been hit the hardest over the past year and half.
Full-year 2019 GAAP net income was $1.79 per share, and earnings per share (EPS) was $1.80. For full year 2020, GAAP net income was $1.16 per share, a 35% decrease, but earnings per share increased 10% to $1.98. The company has a pretty conservative debt-to-equity ratio in the world of mREITs at 3.7 times, with $20 billion of available credit across its financing facilities including $642 million in cash.
But being a huge operator in this space does have its benefits, offering a hedge against the sort of negative market conditions we saw over the past year and a half. It does however, also present challenges for achieving continuous growth, particularly in a low interest rate and high inflationary market.
The unknowns of the future
While it appears the commercial market is recovering, there are still a lot of risk factors stacked against the growth of Starwood Property Trust and other mREITs over the next few years. Inflationary markets are notoriously tough on fixed-interest investments such as mortgages. If a mortgage receives a specified amount of money for a long period of time, in a rising inflation market, that fixed-rate payment loses value the longer it's held. The value of $1,000 today isn't the same as $1,000 in five years, especially in our current market where the inflation rate is 5% and rising. Thankfully, 94% of the loans held in the company's portfolio are of the floating-rate variety, which are tied to a specific index and fluctuate as interest rates rise or fall.
But that brings another concern into play: low rates. Low interest rates, like the ones we're seeing today, also present unique challenges to mortgage REITs. When rates are down, the interest collected on newly originated loans, or floating-rate loans that may have lowered as the index rate lowered, puts pressure on revenues.
There is discussion of raising interest rates in the near future to help combat the real estate crisis and rising inflation, but it's unlikely rates will increase dramatically over the next three years. For Starwood to grow, it has to create more loans, which will be difficult as certain sectors are experiencing low demand, high vacancies, and downtrending rental rates.
In Q1 2021, the company originated or acquired $2.7 billion worth of assets, with $2.2 billion being in the commercial sector and 45% of th commercial loans being multifamily property. Multifamily is in high demand as investors try to increase the supply of housing. making it a likely pillar of the company's lending business in addition to infrastructure loans over the next three years.
Where the company could be in three years
Despite major challenges with loan defaults in the commercial space, Starwood's share prices have not just rebounded but surpassed pre-pandemic highs, earning confidence in where the company is headed.