Billionaire Barry Sternlicht predicts that some office buildings will be transformed into parkland or fields of grain due to the impact of a severe crisis.

Billionaire Barry Sternlicht predicts that some office buildings will be transformed into parkland or fields of grain due to the impact of a severe crisis.

The Hurricane Over Real Estate: Barry Sternlicht’s Concerns and Insights

Renowned billionaire investor Barry Sternlicht recently expressed his concerns about the current state of the real estate industry. In an interview with David Rubenstein, co-founder of The Carlyle Group, Sternlicht compared the industry to a category 5 hurricane, with a black cloud of uncertainty hanging over it until there is clarity on the Federal Reserve’s long-term plans. Known for his criticism of the aggressive interest rate hikes by the Fed, Sternlicht believes that the real estate sector has become a victim of central banks’ efforts to control inflation.

This turbulent environment has resulted in commercial real estate transactions becoming either prohibitively expensive or nearly impossible to finance. Sternlicht shared an example of Starwood, one of the world’s biggest players in residential and commercial real estate, reaching out to 33 banks for a loan on a small property, but receiving only two offers. These challenges have led Starwood to face redemption requests from investors in some non-public funds and even default on a $212.5 million mortgage for an Atlanta office tower.

Sternlicht reminded the industry that Starwood isn’t alone in these struggles. Office real estate owners, in particular, are suffering due to high vacancy rates. Both Blackstone and Brookfield Asset Management, two of Starwood’s major corporate landlord peers, have stopped making payments on offices with high vacancy rates as a result of the work-from-home trend. This has led Sternlicht to predict that the office sector will be divided into haves and have-nots, with many have-nots potentially going out of business.

“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,” Sternlicht humorously remarked.

The concerns raised by Sternlicht find support from other industry experts. Morgan Stanley warns that the ongoing crisis in commercial real estate (CRE) could exceed the impact seen during the Global Financial Crisis of 2008. Capital Economics goes even further, suggesting that office values may not recover until as late as 2040.

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Distressed office real estate assets have surged during the second quarter, increasing by 36% to a total of $24.8 billion. This is the first time since 2018 that hotels or retail haven’t held the top spot for most distressed assets. With approximately $1.4 trillion in commercial real estate debt due by the end of 2024, some CRE executives have cautioned that an “apocalyptical” downturn is impending as borrowers face the need to refinance amidst higher interest rates.

To compound matters, Sternlicht warns that if the commercial real estate sector continues to deteriorate, it could result in another round of regional bank failures, resembling the financial turmoil witnessed in March with Silicon Valley Bank and Signature Bank. This concern stems from fears of a “doom loop” scenario in which regional banks with exposure to commercial real estate cause consumers to question the safety of their deposits. Such apprehensions could prompt depositors to move their funds to larger, more secure banks, thereby pressuring smaller banks to stop making CRE loans and recall existing loans in order to strengthen their balance sheets. This could force CRE borrowers to sell their properties in a weak market, hastening the downward spiral and potentially leading to further deposit withdrawals and bank failures.

In fact, Sternlicht goes so far as to predict that as many as 400 or 500 banks could fail under such circumstances.

However, in the face of these challenges, Sternlicht has always found a way to turn adversity into opportunity. Drawing from his past experiences, he highlights how he built his multibillion-dollar empire on the back of a single risky bet following the savings and loan (S&L) crisis in the 1980s. During that time, he started Starwood Capital Group and purchased apartment buildings from the Resolution Trust Corporation, a government entity tasked with liquidating assets from failed banks during the S&L crisis. With a stroke of luck, apartment values skyrocketed within 18 months, allowing Sternlicht to sell the portfolio to the late billionaire Sam Zell’s Equity Residential for a 20% stake in the company.

Now, Sternlicht envisions a potential “second RTC” if more banks were to fail, presenting him with an opportunity to rewind the clock and acquire distressed assets at discounted prices. “They [the failed banks] will have to sell,” he asserts, perceiving it as “a great opportunity.”

While the real estate industry navigates the ongoing hurricane, it is clear that Barry Sternlicht offers unique insights into the challenges it faces. Whether his predictions hold true or not, the world watches with anticipation, waiting to see if he can turn this storm into an opportunity for success once again.