Why This Mortgage REIT Helps Me Sleep Well At Night
- There could be value to the size of the circle, but an intelligent investor should pay close attention to the nucleus.
- So today I wanted to provide an update on my top K.I.S.S. in the commercial mortgage REIT sector.
- “The beauty of the stock market is that it gives us the luxury to avoid sectors and/or businesses that are outside our circle of understanding.” – Mohnish Pabrai.
A few days ago I wrote an article on Starwood Property Trust(NYSE:STWD), a commercial mortgage REIT with business lines that include lending (56%), investing & servicing, and property owned (25%). Within the lending segment, STWD makes loans on the residential side and the commercial side – both senior secured (first mortgage loans) and mezzanine loans.
There are a lot of moving pieces to the STWD business model, as I explained,
It’s important here to point out that STWD is not a “pure play” senior secured lender like Blackstone Mortgage (BXMT), TPG Real Estate (TRTX), and KKR Real Estate (KREF). These 3 REITs generate most of their revenue from lower risk senior secured loans, while STWD and Apollo Commercial (NYSE:ARI) are diversified REITs that generate complexity risk.”
I’ll be the first to admit, when I see a company like STWD that appears more complex, it’s not an automatic Sell. I think it’s important to analyze the business in greater detail in order to determine whether the returns justify the risk. Simply put, there could be value to the size of the circle, but an intelligent investor should pay close attention to the nucleus of the circle, that is the company’s circle of competence.
Understanding the limits if your own competence is valuable, as venture capitalist Fred Wilson explains,
The only way you win is by knowing what you’re good at and what you’re not good at, and sticking to what you’re good at.”
Regarding STWD, my gripe is that the company is continuing to grow the perimeter of its circle. The commercial mortgage REIT is now making residential loans and investing in big box net lease retail properties. While I am sure these sectors are profitable, the reason I make investments in commercial mortgage REITs is because of the lower risk profile of the senior secured loans.
STWD is not the only commercial mortgage REIT that’s straying away from its circle of competence. I recently wrote an article on Apollo Commercial and I explained,
Apollo has more subordinate loan investments than most of the direct peers…It’s important to recognize that loan defaults are much higher for subordinate loans than senior secured (first mortgage) loans.”
There are a growing number of new entrants to the commercial mortgage REIT sector and I think it’s important for investors to recognize the difference between a K.I.S.S. (keep it simple) platform and a more complex operation like STWD and ARI. I explained,
This new wave of capital is creating a market that is more competitive and this will require investors to recognize that credit management is the differentiator between the best and worst companies.”
So today I wanted to provide an update on my top K.I.S.S. in the commercial mortgage REIT sector. Always remember that before you hit the Buy button for any investment you are making, ask yourself, “is the thrill of victory worth the agony of defeat.”