Billionaire Sternlicht sees ‘Category 5 hurricane’ spurred by Fed rate hikes
Barry Sternlicht, the billionaire investor who built a reputation as a bargain hunter in financially turbulent times, is readying his next bets.
The Starwood Capital Group chairman scooped up distressed assets in the aftermath of the U.S. savings and loan collapse and later in the Great Recession. He’s eyeing opportunities again, as the sharp increase in interest rates deflates commercial real estate values.
“We’re in a Category 5 hurricane,” Sternlicht said in an interview taped in June for an upcoming episode of "Bloomberg Wealth with David Rubenstein." “It’s sort of a blackout hovering over the entire industry until we get some relief or some understanding of what the Fed’s going to do over the longer term.”
Starwood, with $115 billion in assets under management, isn’t immune. It has faced redemption requests at a nontraded real estate investment trust. And more recently, the firm failed to refinance or pay off the $212.5 million mortgage on an Atlanta office tower.
The predicament is unlike past real estate downturns, when aggressive risk-taking in the property industry bled into the broader financial system. This time around, Sternlicht said, commercial real estate is collateral damage in the Federal Reserve’s efforts to calm inflation with rate increases.
Financing now is more expensive and harder to come by. Landlords with floating-rate loans are facing the prospect of higher debt payments. While office vacancies pile up in the remote-work era, demand for other property types — apartments, warehouses, hotels — remains strong for now. That could change in a recession.
In the meantime, tight credit conditions are complicating developers’ efforts to start projects or refinance existing buildings. In one recent example, Starwood reached out to 33 banks for a loan on a small property and received just two offers, Sternlicht said.
Lenders are also reluctant to take possession of struggling assets. In one case where Starwood tried to surrender an office building, the lender instead offered to restructure the loan.
As a lender itself, Starwood also has been on the other side of the situation. After the firm provided financing to a well-known landlord that planned to renovate a Washington office building, the borrower walked away from the project. Starwood got the building at a large discount to what the previous owner paid, Sternlicht said, but it’s spending money to lease up the property at a time of sagging demand for office space.
Lenders throughout the U.S. face similar challenges, with an estimated $1.4 trillion in commercial real estate debt coming due by the end of 2024.
“You could see a second RTC,” Sternlicht said, referring to the Resolution Trust Corp., the government entity charged with liquidating assets of the savings and loan associations that failed in the late 1980s and early 1990s.
“You could see 400 or 500 banks that could fail,” he said. “And they will have to sell. It also will be a great opportunity.”
Sternlicht, 62, launched his own real estate firm in the time of the RTC, buying up apartments and selling them 18 months later to the billionaire Sam Zell at triple the purchase price.
Starwood also landed deals following the financial crisis, including the $2.7 billion purchase alongside other investors of some assets of Corus Bank from the Federal Deposit Insurance Corp., which provided low-cost financing for the transaction to hasten a sale.
Sternlicht sees parallels now as the FDIC looks to sell off commercial real estate loans held on the books of Signature Bank, which failed in March.
“The government’s going to prop up the value of that portfolio by providing very cheap financing to it,” he said.
In his interview with Bloomberg, Sternlicht discussed the repercussions of interest rate increases and tightening credit. He also spoke about his outlook for office landlords, how he got started in real estate and where investors should put their money.
For Sternlicht’s full interview, watch Bloomberg Wealth With David Rubenstein at 9 p.m. New York time on July 25. This interview was recorded on June 28 in New York. Questions and answers have been condensed and edited for clarity.
Many people think the real estate market’s going to be in trouble because high interest rates are making it more and more difficult for people to service their loans. And we’re going to have a lot of defaults soon. What do you think about that observation?
Anything with a fixed income stream is worth less when rates rise. And usually, real estate’s the culprit. We often cause calamities in the economy. Banks get overzealous, lend 100% of cost.
In this case, we really were an accidental consequence of the Fed’s actions. We didn’t really cause this problem. Banks hadn’t stretched loan-to-values. And the underlying fundamentals in most of the asset classes in real estate are OK right now. The apartment market, the industrial logistics market, the hotel markets — those are all in good shape.
But there’s no question that the Fed has reacted dramatically to try to slow the economy down — quite late, obviously — and that has impacted real estate values. Yields on properties are moving up to reflect this higher interest rate. And the supply of credit to the industry has curtailed dramatically.
You’ve been critical of the Federal Reserve. You feel that they raised interest rates too much too quickly. What should they have done in response to COVID?
I’m empathetic to the situation of Jerome Powell. We had to increase rates. We should have done that much earlier. Powell shouldn’t have had negative interest rates. He shouldn’t have been buying mortgages into May of ’22. That should have stopped so much earlier.
But when he finally stopped, he went in the other direction, and he went so far so fast. And I’m saying, “Just wait. Wait to see the impact of what you’ve done.” Because, like, the real estate complex, we don’t explode overnight. We explode in a series of explosions over the next year and a half as loans mature and people can’t pay them off.
When you say these things publicly that are critical of the chairman of the Fed, does it get to be more difficult to get a meeting with him?
I’m actually talking to him and the Fed governors on behalf of my industry as a whole. A lot of us, including ourselves, we have interest-rate caps in place on our loans. So currently we have no issue.
But the cap will expire. And then instead of paying 1% or 2% because we have a cap, or 4%, we’ll be paying 8% or 9%. And many assets won’t be able to cover debt service. And so you’ll be having negotiations with your lenders. And you’ll have to rewrite these loans. And there’s going to be a serious credit contraction.
The country in any asset class has not adjusted to that cost of capital yet. But it’s coming. The economy will slow. You can see the numbers. CEO confidence is down, consumer confidence is down, retail sales are down. The service economy is wickedly strong. It just feels like the last gasp before we actually settle into what should be — what you’d expect to be — I hope it’s a shallow recession. I hope he can pull that off. That would be quite an execution.
Sometimes people are saying that the best investment opportunity now is distressed real estate debt — that you can buy the debt from banks at a discount. But do you think it’s too early for that?
You know, we were gonna give back an office building. And they said, “Well, not so fast. If you want to, we’ll restructure the loan. And we’ll cut the loan in half. And you put the money in here. And we’ll take this as a junior note.” Because the banks don’t want the assets back. They’re not set up to carry these assets. It’s not their business.
So you’re beginning to see stuff. We’re going to see this big trade of the [Signature] Bank portfolio. That’s going to be a benchmark for market.
A lot of fortunes were made in the real estate world in ’07-’08 when people bought distressed real estate. The late ’80s too, when the RTC was here. Do you see funds being formed to buy these assets? But you think they won’t be available for a year or two?
Right now you have an unusual situation in the real estate markets because everyone’s sort of looking at the yield curve. And it says rates will be lower later. Everyone says, “You know, survive till ’25. Hold onto your assets.” So transaction volumes have plummeted.
Unless you have to sell something today, nobody wants to sell anything today. They think tomorrow will be rosier. So for the most part, everybody’s pushing any sales back. But what you’re seeing is when a loan is maturing and a borrower can’t cover the current debt service. Something’s gotta give. Unfortunately, we’re also a lender.
Are we going to change the way office buildings are really valued in the future because tenants aren’t going to need as much space? Or do you think eventually the tenants will come back and the employees will come back?
The work-from-home phenomenon is a U.S. phenomenon. If you go to England or Germany, rents are up, and vacancy rates in the top German property markets — Berlin, Frankfort, Munich, Hamburg — are less than 5%. People are back in the office. You and I go to the Middle East, they’re full. We have offices in Asia, they’re full. So this is a U.S. situation.
In the U.S. you have two markets. The nice buildings will stay rented and my guess is at pretty good rates. And the B and C stuff is going to be — maybe fields of grain or something. It’ll be very pretty. We’ll have all these little mid-block parks in New York City because there won’t be anything else to do with those buildings.
The other thing about office is AI. AI is going to hit a couple of these industries that have been big users of office space. So that’s sort of a big question mark in the investment equation.
Let’s suppose I’m an average person. Where should I put my money as an investor in real estate?
High interest rates are depressing the number of single-family home units that have been built so now you’re having an ever-increasing scarcity of residential. Given the cost of construction, the whole residential complex — including single-families for rent, multifamily, the housing market, even residential land — I think they make interesting investment opportunities today.
Is it a good thing for people to now invest in a real REIT?
I think real estate has a nice place in the balance sheet of any individual. In the pandemic, we raised a special-situations fund and bought 15 names in the REIT business, and we were up, like 70% at one point. We’re going to do that again. And if you take a long-term view, some of these are good companies with the wrong interest-rate environment. I wouldn’t even say they have the wrong balance sheet, but they are so out of favor. There are some really good buys out there. So if you’re clever, you could buy some public REITs.
What kind of return should an average REIT investor expect?
In the mortgage REIT, Starwood Property Trust, we’re paying a 10% dividend. So you get that and any appreciation in the stock, and the stock’s currently trading below book value. It usually trades above book value. It used to trade at 1.23 times and now it’s trading at .9. So if it reverts, you’ll get a 15% return. We’ve averaged 11.3% over 10 years.
Why should somebody want a career in real estate? Why is that a good business to be in?
You’ve got to find niches, and there are a lot of niches in real estate. And it’s very micro, block by block. If I didn’t have my firm today, could I buy — even in a city like New York — and redo apartments and housing. I could make money doing that. I have a friend of a friend who’s bought 300 homes. He turned living rooms into bedrooms, put them all on Airbnb. He’s earning a fortune and using Airbnb as his distribution set. It’s a giant industry. There’s always something to do.
You were based in the northeast part of the U.S. for much of your career. You grew up in Connecticut, you were born in Long Island. But you picked up and moved to Miami. Why did you do that a few years ago? And any regrets about moving to Miami?
Well, my mom’s down there. And I got divorced. That was one reason. Change your life, start over. There was obviously a tax benefit to doing so. And I had sold an interest in my firm at the time. I was based in Connecticut. I was based in Greenwich, our headquarters was there. I looked at my travel calendar in a normal year and I was only home for about a third of it. So I didn’t think it’d be that hard to move and make that my base of operations. It turned I caught the wave perfectly.
I was an early settler into Miami. And, you know, the home prices probably tripled there. I should have bought everything with my house. I would have had the best-performing real estate fund in the world.
If your mother came to you and said, “I have $100,000. I need to invest it somewhere. Where should I invest it?” You would say where, real estate?
Today if you look at my portfolio, I have a significant amount of cash that I never had before because I’m getting 5% for the cash. Pretty soon I’m going to just start deploying that capital when I can see the sun coming through the clouds of the Fed’s movement. When the Fed basically tells you they’re done, I think real estate will catch a very firm bid.
Also, I would look offshore for a bit of my money. I’d invest in some of the nations without the deficits of the United States and enjoy some diversity to my investments.