Investors regularly ask me about the two great fears of today: rising interest rates and a potential economic recession.
While a recession may not happen, interest rates will definitely continue to move higher. So let me tell you about one type of stock, with a couple of recommendations that will be good investments for both scenarios…
Higher interest rates are good for lenders and not so good for borrowers. While most companies earning interest income also carry debt to leverage their equity, you will find a wide range of business models from the companies making money off the lending.
Finance real estate investment trusts (REITs) offer very high yields, but most potential investments in this category are subject to significant interest rate risk. I recommend steering clear of companies that invest in residential mortgage-backed securities. These companies leverage up their equity by six to eight times or more. Because of the massive borrowing, they are significantly at risk from higher interest rates.
Commercial mortgage REITs offer a much safer way to get a high dividend yield. These companies use a lot less leverage and have more conservative understanding standards for their loans. As we invest in the face of a possible recession, the best course is to invest in the largest and most conservatively managed companies in any sector.
As of the end of 2021, Blackstone Mortgage Trust (BXMT) had a commercial mortgage loan book of $23.6 billion. These loans are almost 100% floating rate, so the company’s interest income will grow with rising rates. In 2021, the company funded $12.9 billion in new loans and had $7.2 billion repaid or sold, for a net increase of $5.7 billion. The loan portfolio growth is an excellent indicator that the business remains strong.
The loan-to-value ratio for the portfolio at the end of December stood at 64.4%. The low LTV provides a significant cushion if the economy goes into recession.
Blackstone has paid a $0.62 per share quarterly dividend since the second quarter of 2015. If profits exceed the mandatory REIT payout level, the company will pay a special end-of-year distribution. BXMT currently yields 7.8%.
Starwood Property Trust (STWD) reported a year-end loan portfolio worth $24.1 billion of floating-rate assets. In 2021, the company made $16.7 billion of new investments, including $10.0 billion of new commercial real estate loans. Over the last five years, Starwood Property Trust has expanded its portfolio beyond most commercial real estate lending. As of the end of 2021, the portfolio LTV stood at 61%. Here is a breakdown of the portfolio:
The Starwood Property Trust dividend has been steady at $0.48 per share per quarter since the 2014 first quarter. As with BXMT, if STWD needs to pay more to stay within the REIT 90% payout, expect a special dividend at the end of the year. The shares currently yield 8.0%.
These two commercial finance REITs have portfolios with conservative LTVs and floating-rate loans. They provide great yields and excellent rising interest rate participation.
My Dividend Hunter members get more than two dozen more stocks like these, with high yields and specially selected to benefit as interest rates rise and even if the economy may slow down.
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