Q3 2023 Starwood Property Trust Inc Earnings Call
Greetings and welcome to Starwood property Trust's third quarter 2023 earnings call.
At this time, all participants will be in listen only mode.
A question and answer session will follow the formal presentation.
If anyone should require operator assistance during the conference. Please press star zero from your telephone keypad. Please.
Please note this conference is being recorded.
At this time I'll hand, the conference over to Zach Tanenbaum director of Investor Relations.
Zach you may now begin.
Thank you operator, good morning, and welcome to the Starwood property Trust's earnings call.
This morning, the company released its financial results for the quarter ended September 30th two dozen twenty-three filed its Form 10-Q with the Securities and Exchange Commission and posted its earnings supplement to its website. These documents are available on the Investor Relations section of the company's website at Www Dot Starwood property Trust Dot com.
For the call begins I would like to remind everyone that certain statements made in the course of this call are not based on historical information and May constitute forward looking statements.
These statements are based on management's current expectations and beliefs.
Subject to a number of trends and uncertainties that could cause actual results to differ materially from those described in the forward looking statements.
I refer you to the company's filings made with the SEC for a more detailed discussion of the risks and factors that could cause actual results to differ materially from those expressed or implied in any forward looking statements made today.
Company undertakes no duty to update any forward looking statements that maybe made during the course of this call.
Additionally, certain non-GAAP financial measures will be discussed on this conference call.
A presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP.
Reconciliations of these non-GAAP financial measures the most comparable measures prepared in accordance with GAAP can be accessed through our filings with the SEC at Www Dot FCC dot com joining.
Joining me on the call today are Barry started like the company's chairman and Chief Executive Officer.
Monica the company's President Rina <unk>, the company's Chief financial officer with that I'm now going to turn the call over to arena.
Thank you Zach and good morning, everyone.
This quarter, we reported distributable earnings our D E F 158 million or 49th that's for sure.
GAAP net income was 47 million or 15 cents per share.
GAAP book value per share ended the quarter at $20.18 with unappreciated book value at $21.15.
This book value metrics include $404 million or $1 29 per share.
First related to our theory and infrastructure lending business.
Including $15 8 billion of commercial loan $2 3 billion of infrastructure loan and 535 million of combined Arielle.
Beginning my segment discussion this morning, if commercial and residential lending, which contributed D E 207 million for the quarter, our 64 cents per share.
In commercial lending, we had 762 million of repayments during the quarter, which outpaced fundings of 263 million.
Subsequent to quarter end, we collected another $331 million in repayment.
This includes 52 million from a nonaccrual loan on a retail and entertainment assets in New Jersey, which represents 90% of the retail exposure in our loan portfolio.
Cause alone if on cost recovery and the cash received is here to reduce basis.
Our portfolio of predominantly senior secured first mortgage loans ended the quarter at $15 8 billion with a weighted average risk rating of 2.9.
Of the 600 million balance decline from prior quarter $160 million was due to foreign currency fluctuation. This was offset by the FX impact of our foreign denominated debt as well as our FX hedges, which together had unrealized gain totaling $153 million.
As a reminder, we had 100% of our expected cash flow exposure on non USD loans, including both projected principal and interest.
Turning to see so we have previously discussed the third party software, we used to model our seatbelt restart.
That model in turn utilized as macroeconomic advisers for purposes of determining the economic outlook.
And running our third party model this quarter, we selected a more pessimistic outlook for office.
Which increased our general reserves by $51 million, bringing our total reserves to 280 million of which 177 million relates to U S.
When looking at our loan reserves. It is important to look beyond just our seatbelt reserve some of our loans have been moved to Oreo, while some loans that are still on balance sheet have reported charge offs.
Neither of these appear in our GAAP Stifel Reserve, although both have already been reflected as a reduction to book value.
When we include these components are commercial lending reserves are two point to 4% of our lending portfolio, which is at the median of our peers. Despite our low office exposure.
During the quarter, we placed one new loan on non accrual of $61 million mortgage and mezzanine loan on a multifamily property in Portland, Oregon, which Jeff will discuss.
Quarter end, our nonaccrual loans and Oreo represented less than 4% of our total assets.
Next I will discuss our residential lending business.
Our on balance sheet loan portfolio ended the quarter at $2 5 billion, including $873 million of agency loans.
We continue to be patient by the London as held to maturity portfolio repay debt.
Despite our GAAP Mark these bonds continue to prepay at par.
We received 66 million of par repayments during the quarter and 180 million year to date.
Lower prepay speeds continue to benefit our retained our MBS portfolio, which ended the quarter at 451 million.
As a reminder, we fully hedged the interest rate exposure in this portfolio with our hedges, having a positive mark of 196 million at quarter end after $25 million of cash receipts in the quarter.
Next I will discuss our property segment, which contributed $23 million of D. E. R. Seven cents per share to the quarter.
Of this amount 14 million came from our Florida Affordable housing fund, where we rolled out the HUD maximum allowed rent levels discussed last quarter.
James and HUD Max rent calculation. This year resulted in 3.8% rent growth being deferred to 'twenty 'twenty four.
This portfolio was three 7% blended fixed and floating rate debt with just under four years of average remaining duration continues to be an asset and gives us ample time to wait for an opportune time to extend the debt in the coming years.
Turning to investing and servicing segment contributed D E F 16 million or five cents per share to the quarter.
In our special servicer are active servicing portfolio increased from $5 7 billion to $6 1 billion. We continue to see loans transfer into servicing with $700 million of news on transfers this quarter, nearly two thirds of which or office.
Our named servicing portfolio declined to 101 billion in the quarter with new assignment of 2.4 billion offset by $3 billion in maturity.
In our conduit Starwood mortgage capital, we completed two securitization totaling 63 million at profits consistent with historic levels, we expect to see higher volumes from this business in the fourth quarter and into 'twenty 'twenty four as long maturity pick up.
And on this segment's property portfolio, we sold two assets in the quarter for a total of $35 million in proceeds resulting in a net GAAP gain of $11 million and a net D E gain of $6 million.
Concluding my business segment discussion is our infrastructure lending segment, which contributed D E of $9 million or three cents per share to the quarter.
The majority of our investing this quarter was in a segment, where we entered into 444 million of new loan commitments.
Fundings on these new loans of 351 million outpaced repayments of $265 million, bringing the portfolio up slightly from last quarter to $2 3 billion.
On the Stifel front, we charged off $11 million of our specific reserve related to a legacy GE investment that we discussed last quarter, which resulted in a corresponding P E law.
I will conclude this morning with a few comments about our liquidity and capitalization.
Our liquidity position remains strong at $1.1 billion. After the 300 million repayment of our unsecured notes at maturity on November 1st.
This does not include liquidity that could be generated through sales of our assets in our property segment for that capacity that we have via our unencumbered asset and term loan b.
As a reminder, 83% of our total outstanding on and off balance sheet debt is non mark to market as is 91% of our commercial lending debt.
With the repayment of our unsecured notes last week, we now have no corporate debt maturities until December 31st 2024.
Our leverage remains low with an adjusted debt to underappreciated equity ratio of just 2.42 times at quarter end or 2.37 times after the repayment of our unsecured notes.
With that I'll turn the call over to Jeff.
Thanks Rina.
Maintained very low leverage at just 2.4 turns today and invest it in every quarter since our inception, including $650 million this quarter and $2 7 billion in the last 12 months.
This quarter's originations were across business segments, but primarily in our very accretive low loan to value energy infrastructure lending segment with expected returns in the high teens.
Despite higher interest rates today, many of our borrowers continue to execute their business plans and loan repayments have continued to outpace our conservative expectations. This year, giving us significant capital to accelerate our investing pace.
<unk> continue to build our liquidity.
Rina mentioned, we are sitting on near record cash today.
Due to the accordion nature of our bank warehouse lines, we are able to delever, our balance sheet with excess cash by paying these lines down reducing our interest expense by an average of sopra plus 260 basis points today.
This means for the first time in our history, we are saving and thus, earning 8% on cash balances.
When LIBOR was 25 basis points, we earned less than 3% on our cash which created significant earnings drag if we didn't reinvest excess liquidity immediately.
Earning an incremental 5% on our cash allows us to conservatively bolster our balance sheet with more cash in today's volatile interest rate environment, while creating very little earnings drag.
We have $1 $6 billion in loans financed today on bank lines and soap for plus 275 basis points or higher and as I've explained in the past this relatively expensive bank that is potentially an asset of the firm as it sets us up to opportunistically replaced that secured debt with unsecured debt in the future should our unsecured borrowing.
Spreads normalize to historic averages.
We would then replace secured debt with unsecured bonds at little or no cost.
Creating more unsecured debt as a percentage of total leverage at our company as a key metric along with our already low leverage and achieving our long term goal of receiving an investment grade bond rating.
As I mentioned, we were busy and our energy infrastructure finance business this quarter committing to $444 million of new investments with a high teens return on equity.
We continue to believe this low loan to value business is our most accretive opportunity today and expect to continue to see outsized growth in this business line in the coming year.
Massive demand for power and lack of competition for financing gas fired power plants, and midstream gas transmission and storage assets has allowed us to earn higher unlevered yield on better credits with better structures.
Our asset spreads have increased but our financing spreads have not risen in line with our other businesses, thus, creating even more accretive levered returns for shareholders today.
Our post general electric acquisition portfolio now makes up almost 90% of our Sip portfolio with a high teens Levered return and no realized losses to date.
In commercial lending, our five rated loans decreased by 27% to $555 million or 2% of assets in the quarter and our four rated loans increased by $284 million to 987 million or three 6% of assets, primarily due to the upgrade of the retail and entertainment alone in New Jersey.
He that Rina mentioned paid down by $52 million in October.
We downgraded a $61 million multifamily loan in Portland to a five in anticipation of our taking control for UCC foreclosure on the asset at which time, we plan to sell the property at our basis to an unrelated third party.
We also downgraded a $118 million office thrown in California from a three to a four that's the long winded the payment default at the end of the quarter.
This asset is 75% leased and produces almost 7% debt yield today with a rapidly growing $50 billion market cap tenants expanding into one third of the space and potentially more in the future.
We are finalizing negotiations with the sponsor to give the asset runway to fund accretive leasing through 2024.
Office remains our industry's most challenged asset class, we are happy to have cut our opex exposure in half over the last few years with loans on U S office, comprising just 10, 5% of our assets today.
Following the repayment at par to be quality office buildings in Midtown Manhattan in the quarter. We now have no loan exposure to Manhattan office and no loan exposure to any asset class in San Francisco.
85% of our CRE loans have interest rate caps in place or are fixed rate loans not affected by rate increases and another 6% of interest reserves are guarantees. So we have interest rate protection on 91% of our CRE loans today.
Since COVID-19, we've reduced our exposure to construction loans and therefore, it to future funding obligation.
Construction loans now comprise less than 10% of our funded loan book the lowest in over 10 years.
Pro forma for our senior loan payoff, we expect in Q4. This decrease is reduced our future funding obligations on both construction and non construction loans to just 4% of assets.
Having less future funding exposure and over a year until our next corporate debt maturity allows us to wait for the most opportune time to raise capital in the coming years should we choose to go more aggressively on offense.
In our residential lending business, we were able to offset lower prices on our loan book due to the rising rates with gains in our rate hedges and the value of securities held from previous Securitizations, which have outperformed its prepay speeds have gone down.
In the quarter, we executed on our plan to move over $2 billion in residential loan collateral financed on bank lines to other money center banks, leaving US no regional bank counterparties, extending our facility durations, increasing potential advance rates and most importantly significantly lowering our borrowing spreads and costs.
Finally, this quarter in our res business, we are watching it third party services business, we will call it Starwood solutions.
His team will solicit and execute on third party fee based services, including individual asset or portfolio valuations restructuring and balance sheet consulting collateral management and surveillance underwriting and due diligence for equity portfolios loan portfolios for Securitizations and a full spectrum of capital markets and investment consulting.
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That would solutions will partner with our 200 plus professional team at reset together worked out over 7000 loans totaling $88 billion in value over the 32 years they've been in this business.
We are working with broker partners engaging directly with CRE asset owners to provide these high value add services that we expect will create high multiple fee based revenue for Starwood property trust's shareholders in the future.
Theres never been a better time to launch this vertical when we hope will become our eighth business line.
We are keen to continue to add fee based business lines as a real estate investment in services business that continue to pull us away from a price to book valuation methodology.
I would love to introduce anyone listening brokers owners lenders.
Consultants to our team to discuss what we can do for you and your clients in more detail.
With that I will turn the call to Barry.
Thank you Jeff arenas.
Good morning, everyone. Thanks for being with US it sounds like under the weather I am home with Covid. So.
I might not be.
I'm not sure if you want to call me coherent before but it might be less.
So that might normally be.
Just some quick comments on the real estate markets you know the as you. Many of you know I've been very critical of the fed.
For a number of reasons, but the key one looks economy was slowing on its own and the Covid stimulus package was being spent.
And the shelves were being restocked. So there was no longer so too much money chasing too few goods now you had.
Less money in the shelves were full and you can see that by retail sales what we missed in my forecast was the scale of the buy now makes the spending packages of.
Hum.
Restructure bill, which has kept construction jobs flat, even though rates are producing 500 basis points of the delay in the travel business that supported the economy, while other sectors kind of weekend.
Chips at inflation reductions act and of course, even the remaining money from the American recovery Act have been enough to keep the press the public economy stronger while the private economy began to work well.
And I do think of it as I've been very vocal about that inflation is coming down I think I've been saying that for months on television.
Following that a third of the inflation comes through of rents and rents were trending down, particularly in the apartment segment.
We have a front row seat to so rents are still positive, but they're not running 10, and 20%, which they were running when the fed missed it.
But they are up at 3% or 4% today.
Secure the cute.
Move up the current stat numbers, almost seven seven for rents, it's coming down to three inflation falls below two except for the wildcard of oil prices and I think we're all sort of scratching our head with oil around $80 with the situation in the middle East.
That's up.
That's one of the scratch your head and you cannot.
You cannot forecast what might happen to inflation.
Should there be disruptions to the oil supply, but I will say in general no I think you've seen the top in rates I think Paul and his crew are paying a little more attention to the delays in their own data they actually mentioned it now.
And actually what's happened in the regional banking world and the contraction of credit.
And the reduction of credit in the corporate World from the money Center banks will have a significant impact though its delayed.
This economy. So I think you have seen the top of rates you saw this rapid move 40 basis points and the 10 year just last week that supports the real estate complex, but again I'd say that real estate is the unintended consequence of a fight what that is.
Fighting we we didn't you know he's after inflation, but he's crushing other industries that are material to the U S government like real estate, where significant capital gains helped fuel the revenues to offset the increased interest expense of spending all this money on there.
33 trillion dollars of debt. So I also said the government really can't afford 5% almost 10 trillion of our 33 chilling of that Rolls in next 12 months I think it's slightly more than that it's like a third so you have a $500 billion, you're still coming in very soon and the current interest expense in the budget is.
Absurdly low it.
It will climb probably closer to a trillion dollars if he doesn't relent in and again I I just the door people, who compare what he's doing to volcker Volcker had almost a negligible deficit. He operated with a 200 billion dollar number 333 trillion dollar deficit. All of this is important because it forms a framework of what we're doing.
And what the opportunity set is for us going forward.
So one thing that's happened of course, and one more thing about the deficit the largest delta to the budget in February and March of this year when they just about the deficit would be to Chilean thought.
One three trillion.
What was the decline in receipts.
It was $170 billion, yes.
Oh C O B, which is amazing because if I had it right.
Our guys were off by 40% on a number I don't think they'd have their jobs, we're applauding the sky and he doesn't seem to be realizing what he's doing T. Other sides.
The.
Deficit equation, which is the revenue side, obviously, they sold down their books that that that created $91 billion variance to their original forecast for the deficit and then.
171 billion in receipts interest expense with something like 100 billion off so he was off but.
He knew he was doing but they didn't forecast it properly.
Anyway, what that's led to is a dramatic reduction in transactions.
Corporate M&A everything is down real estate transactions are way down $60 65 per cent that limits. The number of opportunities we have to deploy capital in other players in our fields, but what's more interesting of course is the that the regional banks, which have loaded up on trillium and our real estate debt and the money center banks are getting true.
Mendes pressure from what you see in empower instead of reserve group.
Yeah, I see to reduce their exposure to the real estate that has left us with probably one of the best lending environments.
Maybe the best lending environment. Since we started this firm back in 2000 at nine in the G. F. C. Again, when there was no credit. So there are really remarkable opportunities for private credit and we hope that starwood could position itself as the preeminent private lender in this space going forward much the way.
The other alternative managers have taken advantage of the market seems to enjoy their position in corporate credit and we want to be the guy in and real estate credit. So we are working to make sure that our engines are going and we're fine tuning our team and hope to come out of this I would I'd call it kind of like the <unk>.
Cars on the.
On the let me call it when the cars going around the restrike, our that's the way the flag is out and you're trying to figure out like what when it's safe to get back on the track and drive full speed I do think we're very well positioned for full speed a lot of our business lines are kind of asleep. The conduit business only did two securitizations just aren't a lot of transactions to do.
<unk>.
We have a bunch of Oreo, that's not producing any cash, but there's significant value there and as the markets recover including our largest.
Loans in those books as we can redeploy that capital, which is on the earnings that will be accretive to the company, Jeff mentioned, how accretive not dilutive. It is for us to build up cash and pay off lines.
8% on a cash because we're paying off lines.
And it is true today that the only lender for many of these assets is the existing lender. So a lot of borrowers it just working with the existing lenders, which limits the opportunity set for new capital to come in and deploy capital at these extremely favorable.
Spreads and rates and I think the first thing people talk about the reduction of rates and as al will all follow what happens and I think the forward curve is good I mean, it's favorable rates should come down, but I I I would guess that the curve is wrong and rates will come down further because I don't think you'll have a 300 basis point real interest rates because the economy can't stand.
And it and neither can the global markets the market's too fragile theres no real engine of growth worldwide right.
Right now pulling the global economy up other than maybe defense spending which is a sad comment.
So I think when you see rates that are peaked you'll see spreads come in and that will be a double whammy. So rates will come down as sort of an unnatural world for AAA has to be 250 over or 240 over in some asset classes 180, but they used to be 80. So you should see when sphere dissipates and we're on the back side of this.
Both base rates come down and spreads come down, which means you really want to be a lender today. If you can and hopefully we'll be in a position to go more on offense.
Next year, but we are being careful because it is a minefield out there there are a lot of situations.
Situations today out out in the marketplace, where you can see there could be trouble and we just wanted to be careful with your for stability and to read the consistency of our distributions and transparency, which we've gone from what started this company 13 years ago.
So and I'm really excited to finally get into Starwood solutions business long ago, a small firm named Blackrock created.
Credit Hum.
Software package to help them manage their.
Book and exposures that became Brett Black rock solutions.
They built that into last I looked about a half a billion dollar EBITDA business.
We do many things that banks, do but don't do that well and and other people, which is workouts and Illinois are being the one or second largest special servicer in the nation has a large dedicated team with huge experience backed by a massive database of technology powered database.
That helps it maximize value real estate outfit so.
We are going to expand that business dedicate resources to it. It's incredibly high are we obviously are a lot of there's there's no invested capital just fee streams off of intellectual capital of our business.
I would hope that would become over time, a meaningful new business line for the firm.
And last I mean, I I wanted to talk quickly about.
The question I guess every time I speak about anything today is U S Office U S office is clearly bifurcated, new ESG compliant great buildings are full and holding the rents everything else is a struggle.
There is leasing volume, it's not like there's none in the United States, Although net there's no net new absorption.
But in general in these real estate markets are not an issue there's some overbuilding the multis in downtowns.
In certain markets.
That will pass obviously, the good news for for Multistem and the construction is people can't buy homes, either not being built where they can't afford them two at 50 year lows in homes.
Even though apartment rents are slowing I would expect they would reaccelerate over the coming 24 months or.
Supporting that asset class and everything in the residential asset class. So hotels continue to hold their own shockingly and now they're full with their employees being hired everyone back that they didn't have some margins are normalized.
I would expect the leisure travel to weekend and already is in United States not so much so in Europe, yet, but we have a good margin of safety and we've had some of our hotel loans paid off and one other comment and then I'll stop which is future funding one of the things that sort of worries me is when we don't have the liquidity, we want from loans repaying, but we have commitments.
On future funding and it's among the lowest it's ever been in our firm's history. So I think we've set up.
Ourselves to succeed going forward and the team is locked in and then doing a job and.
And the board again for their gracious supportive and.
And as I since we navigate these choppy waters.
So with that I hope I'm going to stop and thank everyone for listening and we'll take questions.
Thank you.
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One moment, please we poll for questions.
Thank you. Our first question is from the line of Stephen laws with Raymond James. Please proceed with your questions.
Hi, good morning.
First off very hope you feel better soon so I hate to hear.
About the under the weather.
To follow up on your last comment you know can you touch base on office I thought a follow up more detail on office, but it was notable no exposure now too to Manhattan office no exposure at all the San Francisco are there certain marquee assets or class a assets that you would look to do loans with an office or.
Or are you still other opportunities better to put capital to work in and sort of along that front you know how is office potentially going to be disrupted.
Oh, the Leeward filing for bankruptcy.
Barry.
Yes.
Yeah.
I'll I'll do we work then you do the rest of it.
No we were kind of profitable business underneath the business. They just have too many sites and they needed to.
I mean, they got hit with a one two punch of the.
They were recovering nicely gaining enormous markets or.
New lease space and then.
Pandemic hit.
And.
It really hurt them and they they didn't have they never had the right capital structure and Softbank was very reluctant to support the company and increasing the cost of debt and the interest rates Rose of course, they were the only lender to save the company and they'd kind of mostly just kind of walk to wash its hands of the thing, but there is a real viable businesses shared office space business.
This is a real business in New York has a global brand. So my guess is they will reorganize and they will come out as a profitable entity much smaller than they went in they're just getting rid of unprofitable.
Our leases and an end but.
So the impact on the office markets like New York would not be good I think I've read, they're giving back 30 or 40 spots but.
We work well I guess survived certainly without that they can run a profitable company and they'll have to figure out the right overhead levels for a company that's not in the hyper growth because even though they cut them hard they probably have to cut them even harder.
So that's we work in an office, Jeff do you want to give your thoughts and then I'll see if I have any different thoughts on obviously not next to yourself.
Absolutely, let me touch on we work a little bit more for a second you know, we don't know which leases will be given back yet of the 20 million square feet.
Your articles that say that it won't affect the pieces outside the U S. Obviously, we're not sure how that plays out we do have four assets that have exposure. We worked represents one 2% of our total office square footage and less than 1%. If you exclude a doubling at least that's 100% occupied by kicked off that number becomes less and a half.
The percent if you take out of southern California asset, where we have a $4 million letter of credit that covers rent through exploration and of that one half of a percent more than half of that is a berlin asset that they brought current just this week. So them bring your current just this week tells us they like we plan to stay leaving us one asset.
In D C, where 9% of the building is as we work. So we feel really good about what our exposure looks like here, we never really leaned in on lending to two we work occupied buildings. So we felt pretty good about that as far as office. You know you guys know there's been a massive bifurcation.
Between class, a and class b, the best buildings or leasing leasing got incredible rents.
And the weaker buildings are not going to I'm not going to see that kind of rental growth going forward. So we will look at high quality class a office buildings, we will not.
The lease up you know as I mentioned, we got out of two class B office buildings that won't be the case for a lot of Midtown Manhattan class B office buildings with the tenant improvements leasing commissions and money you have to put in on these assets. The net effective rents after free rent just do not.
Cover you and you know a lot of different scenarios and a lot are not able to be converted to Barry I'd hand, it to you to give it any different to say on the office as well.
Office market, where much of the retail market with malls, all going bankrupt and obviously they didn't all go bankrupt and Simon recently reported with real same store sales growth.
So the capital markets dry up for an asset class and obviously offices is a four letter word, but it's like a ball of retail was couple of years ago. So it is a unbelievable opportunity set loans on office buildings today are.
910, and 11% and.
That's one of the problems if you're borrowing at 910, 11%, what's the cap rate on the office, even a good one.
So if you have a trophy building and it's well leased it's really about the stability of the cash flow stream. The rollover schedule you probably would want to do anything that was full today and has the opportunity to roll in the next few years.
But I think we would look favorably with low leverage on some trophy office buildings in major markets that had great credit profiles, because we're gonna get the probably the best returns of any loan we can make and we'll just use our equity real estate underwriting skills to to make sure we feel comfortable about that real estate in that Mark.
And you know we its.
It's interesting what you see in our book I mean, we've we've had.
Sort of great assets with I'd say, not Oh, who we will capitalize borrowers and we have great assets with great borrowers household names largest we're the I think the third largest real estate player and the opportunity set that we compete in.
And and all of US are getting back buildings and and why are we doing that to lenders and we were doing that because if.
If you're in San Francisco, which we're not you have a 30% plus vacancy rate you don't know what the lease rent is gonna be then you're actually lease but you also don't know what the Ti packages.
Here's a borrower now youre looking at the building and say Hey, I got to put another $50 million 50 million and they've got to put 50 million to re tenant that.
And maybe they have to pay down the existing loan and you're just really nervous about the when you look at the exit cap you need in order to justify putting that capital and get a return on it.
Equation is still murky. So you know again as rates fall will sixes and sevens and eights return, even fives to best office buildings, United States. My guess is they will.
At some point in Europe, you're already there you know in Europe, where where rates are lower in Germany, where the 10 years to 80. The office markets are fairly full and rents are actually rising so, but even there where there are some great markets office is still in the investing world.
A four letter word or if it's like not a four letter word, but it's close to it and and so I think at the moment all the press and it will have to play out you'll have to see it play out, but I think it'll be really good opportunities for smart investors to pick off.
Very good leverage returns in our space.
Going through we wouldn't put a red circle around it that was the question. We won't we won't not went to office and when everybody runs away. That's a I think it was David bonderman instead, when their tanks rolling down the streets. It's when he wants to invest I'm not sure where the tank down the street, but for office, we probably are and.
We're not you know you will have to explain every office will only make too so.
Well, we'll have to have a very thin sieve in order to make those up.
In order to make an office alone, but I wouldn't say never I'd say are at the moment, it's not really are our top choice of things to invest in but not never.
Great Yeah, there'd be no shortage of questions on that I appreciate the comments this morning.
Sure.
Thank you.
Our next question comes from the line of Sarah <unk> with P. T I T I used to see.
With your questions.
Hey, everyone. Thanks for taking the question maybe to just pivot from office and multifamily for a second on last quarter's call you spoke to a sort of breakeven cap rate on the multifamily book of about six 5% and a willingness to take over those assets lets say 65 cents on the dollar our spa.
Lance or walk away I was curious if you could provide some updated thoughts there just given you know the forward curve has come up since then we've heard Paul reiterate that he's not thinking about rate cuts yet I'm also just curious where that get youll start looking on a for those assets. Thank you.
Barry do you want to start.
Yeah.
Probably no it's interesting as you think about that.
30 years of doing this capital flows sometimes are overwhelm fundamentals.
And the rent growth is slowing and in some markets like Austin, they're negative.
For apartments, the the asset classes definitely gonna be a favorite for institutional investors going forward you can't take the three trillion all office class a asset class like office shut it off from the investment in our real estate capital has got to go somewhere and hotels are kind of are button for voting for a lot of institutions.
Retail, maybe nobody's rushing to do tons of retail deals today, even though the markets are relatively healthy.
Our industrial possibly it's a bond and the economy is slow so rents or will come down and the pace of rent increases are coming down all.
Also in industrial so I think multis benefit and that was why the comment was we'd be happy to take assets back. We are taking went back in.
Selling it immediately it looks like to us.
Someone in Portland for one of our.
Troubled multi use but I think in general what we said before is true.
We will make more money in my view, if we can take these assets back then we will just staying as a lender, though we will stay as a lender. That's our primary job. So if we're in fact at 65% of value or 65% of the construction costs are 65% of the renovation totally renovation costs.
City by city, but I look at that as sort of an opportunity.
Not a bad thing they are there.
Not going to be empty you know we took back an office building in D. C is interesting building we have it on our books. It was bought by a household name they emptied the building re skin the building.
And then.
Realize that with.
The amount of capital they have to put into re tenant the building.
Defied them walking away from $100 million of equity.
That feels empty. So that's a drag any multis, we'd get back are partially fall and probably yielding five and three quarters six so not not terrible and if we like the assets, which hopefully we do we lend against them it should be good opportunities for us going forward.
Yes, Barry I don't have much to add you know our I did make those comments about our breakeven cap rate being around six and a half as I look at our portfolio. Our in place debt yields are mid sixes today, and we expect they'll stabilize significantly higher than that but obviously its erez you mentioned and the forward curve has gone up so a lot of this is going to depend on what is the forward curve.
It looked like a year out in a year. If people are faced with a refinance will they make the decision to hold on or not and I think that decision to hold on will be mostly about liquidity I think that people will think that theyre going to have an opportunity at a lower cap rate in the future to be able to sell it and will they be able to hold on well they have the cash flow available to buy a cap and waited.
We obviously do we will support the assets as Barry said, they have debt yields that almost that would almost cover today, even on the lowest debt yield assets. It would not cost us a lot to stay in those assets and the right to own them at 65% of cost and wait for a better environment to either refinance them or or to sell them at I think that sums.
Got it.
It's not a cost that would be a great investment for us and we would that we would do that in defense.
Thanks for the comments.
Okay.
Our next questions come from the line of Don Vendetti with Wells Fargo.
With your questions.
Mr. <unk>. Your line is live for a question, perhaps you're muted.
Yes, Jeff should we expect continued growth in infrastructure lending relative to CRE and also can you talk about the competitive dynamic in infrastructure and how those assets would perform if we did go into a recession.
Shanghai is long gone.
Yeah, Sean Sean sitting next to me, we do expect to have continued growth here, we think it's.
Tremendously attractive as I was saying before where I started was to say that our asset spreads what we're earning they've gone up commensurate with what our asset spreads have gone up in other asset classes like CRE lending on the liability side hasn't increased by as much the banks arent retrenching the way that they're retrenching in CRE. So we're able to earn the highest.
Yields that we've had in a while a couple of other headwind tailwind excuse me global power demand is going up massively.
You know it could double or triple in the next 15 years are the estimates that you see so the power plants that we have that start off with a low loan to value generally deleverage over the life of the loan they're going to be worth more not less I think the transition to a more ESG solar wind et cetera world.
He is going to take a lot longer last quarter I talked about the fact that even if it doubles every year it still will get to low 20% of total energy demand in the next 10 or 12 years. So the rest has to be done somewhere the traditional markets are not there in depth to finance the power plant assets in the midstream storage Inc.
Transmission assets, we believe that.
This transition is going to take a lot longer is going to be a great opportunity in the structural nature of these assets, where we get significant amount of deleveraging over the life and ended up at $8 per kilowatt that that feels really cheap on the rule makes this a super attractive.
Asset class for Us Sean Murdock sitting next to me John anything to add to that.
Jeff the only thing I'd add is just that.
Great Jeff fuels, the energy transition, it's going to take longer.
Banks have decided what's their lending strategies that it's gonna come sooner if it hasnt already come so I think that's where we get the tailwind and this sort of market for putting new loans out most banks have decided the transitions happened and they've reduced their lending to traditional energy assets.
Thank you.
Just I want to I want to go backwards, just don't one thing.
Talking about multi is the key.
He is the wave of construction will be over.
Next year.
Construction starts from OTC dropped to 250 that from 600000, or so so that should bode really well for rental growth going forward. So we you know real estate felt long term game also construction is in the in the downtown slot into the suburbs so much so.
It's pretty concentrated you understand a lot of these deals were built for a different rate environment. So there'll be a lot of opportunity I think to take advantage of that if you're a long term player.
And you have the capital to do so I think we have both.
And then on infrastructure, Yeah, I mean, you know infrastructure has been our highest returning asset class. So yes, we will continue to 90.
90% of our book has mentioned is post acquisition the jeans business so teams intact.
Finding great stuff to do and a lot of our investments are in behind that platform right now.
Safer and safer sacred safer place to be.
Thanks, Don.
Our next question next question operator.
It is from the line of Jade Rahmani with K B W.
Thank you very much I'm good.
To hear the comments around started solutions I was worrying that started my admit this miss this moment.
We estimate their seats of reserves and NPL ratios or one and a half 2.5%.
Which on their balances of CRE loans is massive and are still increasing up 25 to 90 basis points per quarter do you see working with the banks the special service assets as the biggest opportunity in front of the starboard solutions initiative.
Yeah, Jade, we we would love to have the banks come to US we're super fortunate to have this LNR business as I mentioned on the prepared remarks, we have over 200 people who've done this for over 30 years and worked out $88 billion of assets. It could be the banks hopefully the FDIC is listening and they give us a call or certainly a lots of property owner.
Pension insurance other investors large players who could use our help the broker network that we use every day at Starwood capital and have relationships with all the biggest brokers. They get asked to do reviews and portfolio valuations every day. They are not experts at working out assets. They are experts at buying and selling and finish.
<unk> assets and we want to go to them and have them bring us the opportunities that they are seeing to both evaluate and helping workouts.
This is what we do dealing with workouts between.
Bespoke interactions between banks and clients four securitizations, we have experience in doing it all in you're one of the people who pushed us over the last few years that we appreciate that we've now hired a team and we think it is an extremely exciting opportunity and hope that people listening who are wondering about their portfolio valuations or asset valuations or what to do.
In a difficult time when it come to a shop that has done this 88 billion times over the last 30 years that we think we have a lot of expertise to offer here and we're really hopeful that we can grow this into something you are right. The time is now.
Just a quick not everyone's got a group that's been with US 30 years.
[laughter] head of the group at the group's been together for 30 years.
Yes, we've been doing this 30 years, but and the Guy who runs it has to do with is actually 30.
One or two years of you know it is much like Guggenheim serves as the front end and for small insurance companies, we should be the backend for many regional banks and maybe some of the larger players like the FDIC, but we.
We do have.
Credible ability to do this I think they'll work in tandem Jade I think the.
The increase in the name or the actual booked would be of 101 or $2 billion in servicing our named servicer that numbers, what's actually being Oreo are serviced by US I think it's seven or eight today are six to eight something like that that number should go back up I mean, you can see we're going to get a lot of business it won't be as profitable as it was.
Before because of that.
See MBS securities the bond documents, a change they'll still be profitable this could be bigger and.
Did that so we will get to work and give it a shot.
And do you see as a follow up M&A as an interesting deployment opportunity within this segment you know theres many financials in the nonbank space that are under duress due to their capital structure and there could be fee income services businesses within that we've seen others in my coverage such as new market.
Grow in that sort of thing sector.
Also the five at brokers and the brokers.
Brokerage arrangement that our phase <unk> trial.
Yeah.
Send us their names.
[laughter] okay.
Anyone listening please call us we got it done.
Sure.
[laughter] yeah.
Yes.
So the premium book value to our peers, obviously, it's accretive if we are able to consolidate the industry, we would love to consolidate the industry. We think we're well positioned to consolidate the industry boards of directors, who are who own a book value that they believe in more strongly than the market believes in or have been unwilling to date to two.
To date us, but we would we would love to go on a lot of dates if you have anyone listening to this call that would like to become part of Starwood.
Thank you.
At this time, we have reached the end of the question and answer session and I'll hand, the floor back to Mr. Stern like for closing remarks.
Thank you everyone for being with us and so good luck navigating these choppy waters, so hopefully about how it would take a vacation.
And the markets will go to bid.
For being with US today, and hope you get Covid take care.
<unk>.
This concludes today's conference you may disconnect your lines at this time. Thank you for your participation.