**The Nightmare Scenario for Commercial Real Estate Investors**
Surging interest rates and the rise of remote work have created a challenging situation for commercial real estate investors. Barry Sternlicht, the co-founder, chairman, and CEO of Starwood Capital Group, a prominent real estate investment firm, warns of a “category 5 hurricane” hovering over the industry. Sternlicht believes that these challenges are a result of central banks’ efforts to control inflation. The combination of rising rates, economic downturn predictions, and bank collapses has made financing commercial real estate transactions extremely expensive or even impossible. Sternlicht’s own firm, Starwood, has faced redemption requests from investors and recently defaulted on a mortgage for an Atlanta office tower.
**The Split Between Have and Have-Not Office Real Estate Owners**
Sternlicht emphasizes that Starwood is not the only company facing these challenges. Office real estate owners, especially, are suffering due to high vacancy rates. Blackstone and Brookfield Asset Management, two prominent corporate landlords, have stopped making payments on offices with high vacancy rates as the work-from-home trend continues. Sternlicht predicts that the office sector will be divided into “haves” and “have-nots.” The more prestigious buildings will continue to be rented at good rates, while the lower-quality properties may become obsolete and potentially repurposed into parks or other non-commercial spaces.
**Wider Concerns and Predictions for the Commercial Real Estate Market**
The worries about the commercial real estate industry and the future of offices extend beyond Sternlicht. Major financial institutions like Morgan Stanley and Capital Economics have expressed their concerns about a potential crash in the commercial real estate market. Morgan Stanley warns that the ongoing crash could be worse than the one experienced during the 2008 Global Financial Crisis. Capital Economics goes as far as predicting that office values will not recover until 2040. Distressed office real estate assets have risen significantly, with MSCI Real Assets reporting a 36% increase in the second quarter. This distress is expected to continue as over $1.4 trillion in commercial real estate debt is due by the end of 2024.
**The Possibility of Another Round of Regional Bank Failures**
Should the commercial real estate sector continue to deteriorate, Sternlicht warns that it could trigger regional bank failures similar to what occurred in March with Silicon Valley Bank and Signature Bank. If consumers lose confidence in regional banks that have exposure to commercial real estate, they may seek out larger, safer banks. This could force smaller banks to stop making commercial real estate loans and require them to call in their current loans to strengthen their balance sheets. This would lead to CRE borrowers being forced to sell their properties in a weak market, further accelerating the downturn. The resulting instability could cause even more deposits to be pulled from banks and increase the number of bank failures.
**Barry Sternlicht’s Experience with Challenging Times**
Despite the challenges facing the industry, Sternlicht has always found a way to turn them into opportunities. He built his billion-dollar empire by taking advantage of the savings and loan crisis in the ’80s. After the crisis, he started Starwood Capital Group and purchased apartment buildings from the Resolution Trust Corporation, created by the government to liquidate assets from failed banks during the crisis. Sternlicht sold the portfolio to Equity Residential and obtained a 20% stake in the company. Sternlicht believes that if more banks fail, there could be another opportunity to acquire distressed assets, referring to it as a “second RTC.”
In conclusion, commercial real estate investors are facing a challenging environment due to surging interest rates and the rise of remote work. Sternlicht warns of a “category 5 hurricane” hanging over the industry. Office real estate owners, in particular, are struggling with high vacancy rates. Major financial institutions predict a crash in the commercial real estate market, while distressed office real estate assets continue to increase. This scenario could lead to another round of regional bank failures, causing further instability. Despite these challenges, Sternlicht remains optimistic and sees potential opportunities in acquiring distressed assets.