Description

Starwood Financial Inc. (SFI) is a niche provider of commercial commercial real estate transactions, that’s taxed as a REIT, created out of the merger of Trinet and Starwood Financial Trust. Starwood assets consist of both - almost 50/50- 1st and 2nd mortgage loans to property managers (mostly the old Starwood) and triple-net leased real estate (mostly the old Trinet). Because most REIT’s operate their businesses as either an equity REIT’s or mortgage REIT’s, SFI’s structure as both has caused confusion in the marketplace. This confusion is also due in part to Starwood’s limited operating experience as a public concern. However, senior management within this organization has some of the best and brightest real estate professionals in the world. They have leveraged the brand recognition associated with the Starwood name and are creating a premier organization with a capital structure similar to none other; with equity like returns (in a “normal” market) and debt like downside protection.

With a current dividend rate of $.57 per share (a yield of about 13.1%), management has already signaled (per the Trinet/Starwood proxy, page 6 of the Q&A section) that 1Q 2000 dividends will be at least $.60, 12% higher that the current rate. This dividend hike can mostly be attributable to the combined companies lower cost of capital and cost reductions in other administrative areas. With Starwood’s contacts within the investment and commercial banking arena and their relatively underleveraged balance sheet (1.1 as of 12/31/99) the organization has the capital resources to continue to drive their growth. Also, with an internal goal of creating a $10 billion commercial real estate finance company (from about $4 billion as of 12/31/99) this growth is more than likely to come not only from internal growth but also from M&A, as seen in their most recently announced (3/21) acquisition of ACRE Partners. This once again demonstrates and authenticates the organization that the executives at Starwood are trying to build as well as the depth of their industry connections.

Recently signed REIT legislation also makes SFI a compelling buy. The REIT Modernization Act, signed by President Clinton in December 1999 will take effect January 2001. One of the things this new law does for REIT’s is it provides REIT’s with additional lines of revenue, within other real-estate related businesses, a major “growth” area in real estate. All this comes at a time as more and more corporate America outsources its real estate roles to third party organizations, with Chase and American Express being two of the most recent companies to make such measures. Most importantly however, this legislation lowers the dividend payout ratio from 95% to 90%. This measure will have huge repercussions for Starwood, as well as other players in the industry, in particular due to their 1.4 debt-service ratio.

The risks associated with owning this stock include limited capital gains and perceived limited growth opportunities in the REIT industry. With regards to the limited capital gain, if you’re looking for total return keep in mind that with the yield going to 14%, you only need the shares to rise by $1 to achieve a total return of over 20%. The spectacular dividend yield allows you to reinvest the dividends into other higher-performing assets, however in terms of a risk-reward ratio you should feel relatively safe to other opportunities. On the issue of growth, Starwood has the capital resources (both public and private) to help drive its growth opportunities as well as take advantage of merger opportunities within the REIT industry. And as we will come to see, as in other industries, bigger really is better (i.e. the recently announced Equity Office/Cornerstone Properties merger). Also, due to the nature of several of Starwoods customer base, private/wealthy entrepreneurial clients that are highly sophisticated real estate developers and owners, their is credit risk assocaited with those clients. However, this risk is mitigated by their quality of the underlying assets as well as their senior lien positions on many of these assets.

As a side note the 52 week high/low, as noted above in the summary section is reasonable due to the limited float that initially existed in Starwood Financial Trust. Upon announcing and further execution of the Trinet merger the the stock was more properly valued to reflect its underlying asset base. The limited float situation took care of itself in the wake of the Trinet merger, yet their still remains not much room for big investors to acquire stock without moving the stock.

To conclude Starwood Financial with a solid dividend yield of 13% at current levels, and looking to expand, is an excellent buy at current levels. As mentioned before SFI’s business model is complex and a challenge to try and understand and value nonetheless, you will be rewarded for the risk you are assuming.

Catalyst

Recently announced merger included internet assets and because of Starwood structure as a REIT their options are limited to how to monetize the value of these assets