Q2 2024 Starwood Property Trust Inc Earnings Call
Speaker Change: Greetings and welcome to the Starwood Property Trust's second quarter 2024 earnings call.
Operator: At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note this conference is being recorded. At this time, I'd like to hand the conference call over to Zach Tanenbaum, Head of Investor Relations. Zach, you may begin.
Speaker Change: At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation.
Speaker Change: If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note this conference is being recorded. At this time, I'd like to hand the conference call over to Zach Tanenbaum, Head of Investor Relations. Zach, you may begin.
Zachary Tanenbaum: Thank you, operator. Good morning, and welcome to Starwood Property Trust's earnings call. This morning, the company released its financial results for the quarter ended June 30th, 2024, filed its Form 10-Q with the Securities and Exchange Commission, and posted its earnings supplement to its website. These documents are available in the investor relations section of the company's website at www.starwoodpropertytrust.com.
Zach Tanenbaum: Thank you, operator. Good morning and welcome to Starwood Property Trust's earnings call. This morning, the company released its financial results for the quarter ended June 30, 2024, filed its Form 10-K ey with the Securities and Exchange Commission, and posted its earnings supplement to its website.
Speaker Change: These documents are available in the investor relations section of the company's website at www.starwoodpropertytrust.com.
Zachary Tanenbaum: Before 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 and are subject to a number of trends and uncertainties that could cause actual results to differ materially from those described in the forward-looking statement. 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.
Speaker Change: Before 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.
Speaker Change: 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. The company undertakes no duty to update any forward-looking statements that may be made during the course of this call.
Zachary Tanenbaum: The company undertakes no duty to update any forward-looking statements that may be made during the course of this call. Additionally, certain non-GAAP financial measures will be discussed in 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 to the most comparable measures prepared in accordance with GAAP can be accessed through our filings with the SEC at www.sec.gov.
Speaker Change: Additionally, certain non-GAAP financial measures will be discussed in 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.
Speaker Change: Reconciliations of these non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP can be accessed through our filings with the SEC at www.sec.gov.
Zachary Tanenbaum: Joining me on the call today are Barry Sternlicht, the company's chairman and chief executive officer, Jeff DiModica, the company's president, and Rina Paniry, the company's chief financial officer. With that, I will now turn the call over to Rina.
Speaker Change: Joining me on the call today are Barry Sternlicht, the company's chairman and chief executive officer, Jeff DiModica, the company's president, and Rina Paniry, the company's chief financial officer.
Rina Paniry: Thank you, Zach, and good morning, everyone. This quarter, we reported Distributable Earnings, or DE, of $158 million, or $0.48 per share. Gap net income was $78 million, or $0.24 per share. Across businesses, we committed to $925 million of new investments this quarter. As a testament to the diversity of our platform, 62% of our investing was in businesses other than commercial lending, which now makes up just 57% of our assets. I will begin this morning with commercial and residential lending, which contributed DE of $189 million to the quarter or $0.58 per share.
Speaker Change: With that, I will now turn the call over to Rina.
Rina Paniry: Thank you, Zach, and good morning, everyone.
Rina Paniry: This quarter, we reported Distributable Earnings, or DE, of $158 million, or $0.48 per share.
Speaker Change: Gap net income was $78 million or $0.24 per share.
Speaker Change: Across businesses, we committed to $925 million of new investments this quarter. As a testament to the diversity of our platform, 62% of our investing was in businesses other than commercial lending, which now makes up just 57% of our assets.
Speaker Change: I will begin this morning with commercial and residential lending which contributed DE of $189 million to the quarter or 58 cents per share.
Rina Paniry: In commercial lending, we originated $353 million in loans, of which we funded $284 million and an additional $113 million on pre-existing loan commitments. Repayments for the quarter totaled $606 million, nearly half of which were off the balance sheet. We had another $624 million of repayments in July for a year-to-date total of $2.1 billion. On the subject of credit, our $14.7 billion loan book ended the quarter with a weighted average risk rating of 3.0, up from 2.9 last quarter.
Speaker Change: In commercial lending, we originated $353 million of loans, of which we funded $284 million and an additional $113 million on pre-existing loan commitments.
Speaker Change: Repayments for the quarter totaled $606 million, nearly half of which were office. We had another $624 million of repayments in July , for a year-to-date total of $2.1 billion.
Speaker Change: On the subject of credit, our $14.7 billion loan book ended the quarter with a weighted average risk rating of 3.0, up from 2.9 last quarter.
Rina Paniry: The vast majority of our borrowers continue to support their assets, investing nearly $2 billion of fresh equity since the beginning of last year. In addition, 97% of our performing loans have some form of rate protection in place, either via rate caps, which have an average base rate of 3.2%, interest reserves, guarantees, or a fixed rate of interest.
Speaker Change: The vast majority of our borrowers continue to support their assets, investing nearly $2 billion of fresh equity since the beginning of last year.
Speaker Change: In addition, 97% of our performing loans have some form of rate protection in place, either via rate caps, which have an average base rate of 3.2%, interest reserves, guarantees, or a fixed rate of interest.
Rina Paniry: Jeff will cover our risk rating changes in greater detail, including two loans placed on non-accrual in the quarter. One was a $46 million multifamily loan in Phoenix that we downgraded from a 4 to a 5, and the other was a $57 million multifamily loan in Fort Worth, which was downgraded from a 3 to a 4. As we signaled last quarter, we foreclosed on two previously five-rated loans.
Rina Paniry: The first was a $124 million senior mortgage loan on a vacant office building in Washington, D.C. that we are converting to multifamily. Although the appraisal resulted in a specific CECL reserve of $9.8 million, we expect to recover in excess of our basis once the conversion is complete. Because we have begun the redevelopment process for this asset, we transferred it to our property segment for financial reporting purposes. We obtained an appraisal in connection with the foreclosure, which valued the asset at our base. As a result, the property was recognized as the carryover basis of our loan with no resulting impairment.
Speaker Change: The second was a $53 million first mortgage and mezzanine loan on a multifamily property in Nashville. We obtained an appraisal in connection with the foreclosure, which valued the asset at our basis. As a result, the property was recognized at the carryover basis of our loan with no resulting impairment.
Rina Paniry: On the topic of CECL, our reserve increased by $33 million to a balance of $380 million, of which 70% relates to office. Together with our previously taken REO impairments of $183 million, these reserves represent 3.6% of our lending and REO portfolios and translate to $1.78 per share of book value. Next, I will discuss residential lending, where our on balance sheet loan portfolio ended the quarter at $2.5 billion. Prepayment speeds increased this quarter and spreads tightened, leading to $62 million of par repayments and a $34 million net positive mark-to-market for gap purposes.
Rina Paniry: This mark includes a $49 million positive mark on our loans, offset by a $15 million negative mark on our hedges, which provided $25 million of cash during the quarter. Our retained RMBS portfolio ended the quarter at $427 million, with a slight decrease from last quarter driven by cash repayments. Next, I will discuss our property segment, which contributed $14 million of VE, or 4 cents per share, to the quarter. This primarily came from our Florida Affordable Housing Fund, where we began rolling out the HUD maximum allowed rent levels discussed last quarter, excluding the 3.8% holdback we expect to implement next year. The majority of these rent increases were implemented in June, so you will see just a partial impact on earnings this quarter.
Rina Paniry: This portfolio of 3.7% blended fixed and floating rate debt with three years of average remaining duration continues to be an asset. Turning to Investing in Servicing, this segment contributed DE of $37 million, or $0.11 per share, to the quarter. In our conduit, Starwood Mortgage Capital, we completed or priced four securitizations totaling $363 million at profit margins above historic levels due to spread tightening in the quarter. Consistent with past practice, the two transactions that priced in June but settled in July are treated as realized for DE purposes, and our special servicer, Eleanor, our active servicing portfolio increased just over 30% to $9.4 billion, its highest level since COVID.
Speaker Change: Consistent with past practice, the two transactions that priced in June but settled in July are treated as realized for DE purposes.
Speaker Change: and our special servicer, Eleanor, our active servicing portfolio increased just over 30% to $9.4 billion, its highest level since COVID.
Rina Paniry: The increase was primarily due to $2.5 billion of transfers into servicing, which will contribute to earnings in the future. Our named servicing portfolio also increased in the quarter to $98 billion, driven by new assignments of $5.1 billion. In this segment's property portfolio, we foreclosed on a $10.1 million hospitality asset that we acquired as a non-performing loan out of a CMBS trust.
Rina Paniry: Consistent with our original investment thesis and a recently obtained appraisal, we expect to sell this asset on our basis in the near future. Concluding my business segment discussion is infrastructure lending, which contributed DE of $24 million or $0.07 per share to the quarter. We committed to $237 million in new loans, of which we funded $226 million and an additional $34 million of pre-existing loan commitments. Repayments and sales totaled $313 million, bringing the portfolio to a balance of $2.4 billion.
Speaker Change: Consistent with our original investment thesis and a recently obtained appraisal, we expect to sell this asset and other assets of our basis in the near future.
Speaker Change: We committed to $237 million of new loans, of which we funded $226 million and an additional $34 million of pre-existing loan commitments.
Rina Paniry: During the quarter, we completed our third infrastructure CLO for $400 million with a weighted average coupon of SOFR plus 2018 and an 82.5% advance rate, which Jeff will discuss in more detail. And finally, this morning, I will address our liquidity and capitalization. This quarter, we successfully repriced our 2027 $591 million term loan B facility, reducing the spread by 50 basis points to SOFR plus 275. We continue to have significant credit capacity across our business lines, with $9.9 billion of availability under our existing financing lines and unencumbered assets of $4.5 billion.
Speaker Change: During the quarter, we completed our third infrastructure CLO for $400 million with a weighted average coupon of SOFR plus 2.18 and an 82.5% advance rate, which Jeff will discuss in more detail.
Rina Paniry: Our adjusted debt to unappreciated equity ratio ended the quarter at 2.29 times, a decrease from 2.33 times last quarter, its lowest level in over two years. Our current liquidity position is $1.2 billion. This does not include liquidity that could be generated through sales of assets in our property segment, leveraging unencumbered assets or debt capacity that we have via the unsecured interim V market.
Jeff DiModica: And finally this morning, I will address our liquidity and capitalization.
Jeff DiModica: This quarter, we successfully repriced our 2027 $591 million term loan B facility, reducing the spread by 50 basis points to SOFR plus 275.
Jeff DiModica: We continue to have significant credit capacity across our business lines, with $9.9 billion of availability under our existing financing lines and unencumbered assets of $4.5 billion.
Jeff DiModica: Our adjusted debt to underappreciated equity ratio ended the quarter at 2.29 times, a decrease from 2.33 times last quarter, its lowest level in over two years.
Rina Paniry: I also wanted to mention that this quarter, our credit ratings were once again affirmed by all three rating agencies. Despite challenging conditions in the CRE space, they collectively recognized our diversity, leverage profile, liquidity position, stable earnings, and credit track record as key elements supporting our ratings. And finally, I would like to share that we were just awarded the 2024 May REIT Gold Investor Care Award, which recognizes communications and reporting excellence in the mortgage REIT category.
Rina Paniry: This is our eighth time receiving the award in the last 10 years, exemplifying our long-term commitment to both our stakeholders and transparent financial reporting. We are honored to once again be recognized by NARATE for this award. With that, I'll turn the call over to Jeff.
Jeff DiModica: This is our eighth time receiving the award in the last 10 years, exemplifying our long-term commitment to both our stakeholders and transparent financial reporting. We are honored to once again be recognized by NARIT for this award. With that, I'll turn the call over to Jeff.
Jeffrey DiModica: Thanks, Rina. As we approach our 15th anniversary this month, we're the longest-standing commercial mortgage REIT of our post-GFC peer group and the only company that has never cut its dividends. We built a diversified, low-leverage business, positioning us to outperform regardless of the market cycle. Our inception-to-date return of over 10% per year is higher than the equity REIT index and more than double the mortgage REIT index over that time. Even though we have the best valuation in our sector, the market has only given us partial credit for this diversification and for the over $4 per share in unrealized DE gains. However, as I will discuss shortly, those gains, which provide a unique safety net to ensure our dividend-paying ability, are likely significantly higher. 15 years later, we aren't really a mortgage REIT anymore.
Jeff DiModica: Thanks, Rina. As we approach our 15th anniversary this month, we're the longest-standing commercial mortgage REIT of our post-GFC peer group and the only company who has never cut its dividend.
Jeff DiModica: We built a diversified, low-leverage business, positioning us to outperform regardless of market cycle.
Jeff DiModica: Our inception to date return of over 10% per year is higher than the equity REIT index and more than double the mortgage REIT index in that time.
Jeff DiModica: Even though we have the best valuation in our sector, the market has only given us partial credit for this diversification and for the over $4 per share in unrealized DE gains.
Jeff DiModica: The 10-year has rallied 75 basis points since we last spoke, and Forward SOFR is now indicating 165 basis point reduction in the Fed funds rate by March, both of which are very good news for CRE credit as they provide relief both through cap rate compression and improved debt service coverage ratios.
Rina Paniry: As Rina shared, our sponsors have contributed nearly $2 billion of fresh equity on our $14.7 billion CRE loan book since last year.
Barry Sternlicht: When rates move like this, we typically see borrowers step up and support their assets more aggressively, and I would expect that to continue. The gains that are reflected on our balance sheet today. We have invested in every quarter since our inception, and as Rina said, we invested $975 million again this quarter across business segments. Thank you, Jeff. Thanks, Rina. Thanks, Zach. And good morning, everyone.
Rina Paniry: When rates move like this, we typically see borrowers step up and support their assets more aggressively, and I would expect that continues.
Rina Paniry: We have spoken often about loans on U.S. office, which are 10% of our assets, but this rate move will mostly help other sectors of our loan book more, like multifamily, which is 21% of our assets and has a blended 6.3% debt yield across 70 loans.
Rina Paniry: Should this rate move hold, both these asset classes will likely stabilize.
Rina Paniry: We have said since the beginning of COVID that we didn't expect any losses from our hospitality book, and I still believe that. And we have said on past earnings calls that we view taking back multifamily assets from undercapitalized borrowers in this cycle as an opportunity to own solid assets at a significant discount.
Rina Paniry: When academics write about this cycle, the focus will be the stubbornly slow unwind of work from home, creating low net effective rents in office that can't cover debt service post Fed hike.
Rina Paniry: We are not immune from that stress, but with only 10% of our assets on loans on U.S. office and owned property gains that are almost as big as the entirety of our office loan portfolio, this narrative won't define us as the cycle enters its final chapters.
Rina Paniry: I will note we avoided the temptation to lean into life science construction and conversion and have only made one loan in Boston's Seaport District. That is our 13th largest office loan and included in our 10% U.S. office allocation. With little to report on our legacy downgrades, I want to talk briefly about the loans we downgraded in the quarter. Thank you for your time. Have a great day.
Rina Paniry: Our one new five-rated loan and two of our new four-rated loans are multis that share a similar story and have the same syndicator sponsor on all three.
Rina Paniry: As lenders, we are taught to learn from our mistakes, and we as an industry should have been more wary of syndicated equity structures who would have a difficult time calling capital in times of distress.
Rina Paniry: We will be going forward.
Rina Paniry: The multifamily assets we have downgraded mostly fall into this category. As rates rose and undercapitalized sponsors ran out of money, they underperformed their business plans, stopped upgrading units, and allowed vacancy to creep up, forcing lenders to step in.
Speaker Change: Fortunately, this is what we do. Our manager, Starwood Capital Group, manages over 100,000 multifamily units, and we have the capital at STWD to take these assets back, finish renovation, insert new management, and ultimately increase debt yields.
Speaker Change: Upon stabilization, we will then decide whether to hold or sell these assets.
Speaker Change: The 1 New 5 Rated Loan is a small multi-loan in Phoenix and 2 of our 4 New 4 Rated Loans are in Texas and all fall into this description. Our largest New 4 Rated Loan is an office in Dallas, very well located near Uptown, where the sponsor recently told us they would no longer contribute capital to support the asset.
Speaker Change: As with the syndicator story of multi, office defaults have had a common thread also. The high cost of re-tenanting due to TIs and LCs is hard to justify at yesterday's basis as net effective rent fall.
Speaker Change: Someone with a strong balance sheet and a better basis that is willing to invest in re-tenanting needs to step in and show strength and conviction to the market to energize brokers and bring in tenants to well-located assets like this one.
Speaker Change: Our borrower's inability to convince the market they were in for the long run allowed occupancy to fall to 57% and our debt yield to deteriorate to 6.4%.
Speaker Change: The team and I visited the asset again in July , and given the great location, we believe there is an opportunity to invest capital into this project to stabilize the tenancy and we'll begin working through that business plan or potentially a partial conversion as we move forward.
Speaker Change: The final new floor rating this quarter is a relatively small $27 million loan on an office portfolio in Dublin, Ireland that is 76% leased and produces a 6.5% debt yield today. It is early stages, but the sponsor is evaluating a large single-tenant lease.
Speaker Change: But should that not be executed, we will need to work with the sponsor on other stabilization plans.
Speaker Change: Should the sponsor choose to walk away in the future, we have the capital and a better basis to step in and help stabilize the asset. As with our other higher risk assets, we will share any major developments on these assets as appropriate.
Speaker Change: Our energy infrastructure lending business continues to be a great performer, with mid-teens levered returns on the loans made since we purchased the platform from General Electric in 2018.
Speaker Change: Importantly, after pricing our third CLO, we are earning these premium returns with 59% of our loan book financed in the CLO market, which gives us term non-mark-to-market financing.
Speaker Change: Our LTVs have continued to fall as the energy demand curve continues to shift higher. Our LTVs are the lowest since we bought this business.
Speaker Change: Last week, we got the results of the annual PJM Capacity Auction, which determines how much power plants are paid to provide excess power to the grid. The results came in well above expectations, which will allow power LTVs to continue to decline.
Rina Paniry: In REITS, our CMBS Conduit Originations business has already made this year what it made in all of 2023, and as Rina said, our special servicer, Eleanor, saw a 30% increase in active special servicing this quarter alone.
Rina Paniry: which will provide tens of millions of dollars of incremental revenue in the coming few years.
Speaker Change: As this cycle continues to play out, we expect the servicer to continue to outperform. Moving to our property segment, we have discussed the approximately $2 billion of embedded DE gains we have created in the seven years we have owned our Florida low-income multifamily portfolio.
Speaker Change: As a reminder, we own approximately 80% or $1.6 billion of these gains.
Speaker Change: Rina discussed last quarter the rent holdback of 3.8% that will be added to next year's formulaic income and inflation-based rent increases.
Speaker Change: Holding cap rate constant, formulaic rent increases over the seven years we have owned this portfolio have increased spare value by nearly 800 million dollars.
Speaker Change: I will remind you, rents cannot be mandated lower in this portfolio.
Speaker Change: Now I want to talk about the next eight years.
Speaker Change: If rents increase at just half the pace of the last 7 years, expenses grow by 2%, and you hold cap rate constant, our portfolio will be worth $800 million more in that time.
Speaker Change: In addition to that, the first 5,300 units representing 21 properties and 31% of the Woodstart portfolio will roll from affordable to market rate in that time period as their affordability restrictions burn off.
Speaker Change: This will allow us to begin to execute on our original investment thesis to create incremental shareholder value by rolling our portfolio from affordable to market rate unit.
Speaker Change: When we purchased these portfolios, we shared that we expected to maintain nearly full occupancy as units rented at the time for 70% of comparable market rate units, creating tremendous demand for these below market units.
Speaker Change: As the remaining 69% rolls in future years, and assuming rents continue to trend higher, one could easily extrapolate the gains after rolling to market to be worth significantly more.
Speaker Change: The gains that are reflected on our balance sheet today, gains yet to be reflected from increasing rents that cannot go down.
Speaker Change: Interesting, where do you start a call in commercial real estate today? We just had the...
Barry Sternlicht: A seminal event, sort of an earthquake in the credit markets and the financial markets with the jobs report coming in so much lower, with few goods on the shelf and too much money in consumers' hands and that. By May of 2022, since he started to increase rates, those industries, healthcare, education, and government, completely not impacted by his rate effort, added 3.25 million jobs. Even though people aren't employed. Because what's driving GDP is a very narrow segment of the economy, data centers, which started capital, are a major player on fire and alone fit as a stimulus package and unique to the United States and propelling our GDP growth faster than our peers because of the scale the AI investments are in.
Speaker Change: than most people thought. And I think most of you know, I've been super critical of how we had inflation because we had
Speaker Change: Too few goods on the shelf and too much money in consumers hands and that Situation was going to clear itself and obviously have has
Speaker Change: May of 2022, since he started to increase rates, those industries, healthcare, education, and government, completely unimpacted by his rate effort, added 3.25 million jobs.
Speaker Change: So what you're seeing now is why you have this selection set up the way it is. You have people not feeling good about an economy.
Speaker Change: even though people aren't employed.
Speaker Change: because what's driving GDP is a very narrow segment of the economy. Data centers, of which Starwood Capital is a major player, are on fire and alone fit as a stimulus package and unique to the United States and propelling our GDP growth faster than our peers because of the scale of the AI investments.
Speaker Change: both in chips and in infrastructure and power.
Jada Senators: and Jada Centers, and it is a quite...
Jada Senators: enormous effort which sits on top of the CHIPS Act, on top of the Infrastructure Bill, and on top of the Climate Bill, which all contributed to the second largest category of employment increase last month, construction jobs.
Speaker Change: up $25,000, when in fact private construction of multifamily is getting cut in half, logistics are down 70%, probably the only office buildings being built in this country are for built suits.
Speaker Change: All of this private investment has now shifted to public investment and carrying the construction workforce, which lost a million jobs in 2007-2008, but it lost no jobs because of the fiscal spending and the shift from private to public spending and infrastructure.
Speaker Change: So I think now you see clearly what we hoped everyone would see was that inflation is below 2% when you take out the rent component of inflation.
Speaker Change: raising rates in 21 when apartment rents are up 20%. And it's why they've missed lowering rates early, because when rents are 1 or 2%, and they're still showing 5.5% for rent.
Speaker Change: And it's coming down. So you look at commodities, the commodity complex oil is at $73. I was just checking wheat and corn this morning. Corn prices and wheat prices were where they were in 2018 and 2016.
Barry Sternlicht: So we're going to see a fall in inflation. You'll see that having 5.3% SOFO in a world of 2% inflation is going to look particularly stupid, and we're hoping to see the cracks.
Speaker Change: So we're going to see a fall of inflation. You're going to see that having 5.3% SOFO in a world of 2% inflation is going to look particularly dumb.
Barry Sternlicht: And the biggest beneficiary from us will be CRE, which was probably the biggest hit hardest. We were the unintended consequence of trying to reduce employment growth, employment pressures, and wage growth. 500 basis point rates, almost overnight, in the commercial property sector, really knocked a lot of people on their butts. Interestingly, for Starwood Property Trust, the rise in rates was good because we would make more money on our floating rate loan, so we have floating rate debt against it.
Speaker Change: 500 basis point rates, almost overnight in the commercial property sector, really knocked a lot of people on their butts. Interestingly, for Starwood Property Trust, the rise in rates...
Barry Sternlicht: But because we're much less levered than our peers going the other way, we will lose less earnings than many of our peers that are more highly levered. So you won't see us drop dramatically if interest rates do hit the 3% SOFR that you're seeing now on the charts for next year. And we are gifted.
Speaker Change: It was good. We would make more money on our floating rate loans, but we have floating rate debt against it. But because we're much less levered than our peers going the other way, we will lose less earnings than many of our peers that are more highly levered.
Speaker Change: So you won't see us drop dramatically if interest rates do hit the 3% so far that you're seeing now on the charts for next June .
Speaker Change: Also, we have 40% of our assets in other asset classes that are doing other things and not necessarily related to our loan book.
Speaker Change: where there are some leases, particularly internationally, with London having an incredible first quarter and most of the continents of Europe having very good rental increases and low vacancy rates. The one exception is Dublin, where we saw we have a $27 million loan.
Speaker Change: The A-markets are leased and eventually credit and their ability to refinance will come back, and then the BNC buildings, which will be, at some point, something else.
Barry Sternlicht: We had an office building for a major borrower in. Our job, from the start, has been transparency, consistency, and reliability, and I'm honored that we've won this award. And hopefully, our ultimate goal of becoming investment grade is not out of reach. So I think it's speaking for a multi-borrower. I mean, he's like, I know I've got negative leverage, but I can look out on the horizon. I see a 70% decline, 50% decline in supply in my market. I just got to get to 26 for the back half of 25.
Speaker Change: And we are gifted, we had an office building to a major borrower in
Speaker Change: One of the household names and we are taking that back. You heard about it from me and from Jeff that will turn into a multi-family. It's a beautiful building.
Speaker Change: and it's not earning anything today. So when I look at our company and its earnings power and I look at the amount of loans we have on non-approval, I look at that as a blessing. It's 30 cents in earnings power, 30 cents and we can turn those assets back around and we will. It's just a question of how fast and how we maximize the capital that's tied up in those assets and we're blessed to be able to do that.
Speaker Change: and take an asset like an office building and convert it to a residential. It's not a complicated conversion.
Speaker Change: And hopefully, as you heard from Rina, we will exceed.
Rina Paniry: $9 million dollar Cecil Reserve that was attributed to that as it was appraised.
Rina Paniry: and recover more than our capital. So looking forward to getting that capital back into an earnings form. We'll be discussing many assets in that portfolio. One of the loans in there is an apartment building in New York City, some units we took back.
Rina Paniry: our job from the start has been transparency, consistency, and reliability.
Rina Paniry: I'm honored that we've won that NARED award again on disclosure. Thanks ACM team and all of our shareholders that might have voted for us for that.
Speaker Change: One other thing I'd say is that this is really good for the real estate complex, and we look forward to going on big offense. There are great lending opportunities because the big picture is, as you've seen in private credit for corporates,
Speaker Change: There is a reluctance of banks to lend, and we should be that player. We should be that bigger player in this space, we're the largest in the country, and we should be the place that people come to finance real estate, both here and abroad.
Speaker Change: So with excess capital and access to capital, we think we can put the money to work extremely creatively and attractively to return in a world that's probably going to get...
Speaker Change: Harder to find yield
Speaker Change: that's attractive. And I think we've proven that this business model, which is different than the others, and hopefully our ultimate goal of becoming investment grade is not out of reach, as we continue to perform and come out of this.
Speaker Change: I think you'll see that the company can really fire on all of the cylinders and not just rely on a couple that have had a good
Speaker Change: One thing that was noted by Rina, but I'll highlight it, Jeff didn't mention again, is special servicing.
Speaker Change: which saw a 40% increase in its book, and I guess that was always our pitch, that special services need to take off again. And in fact, I think you'll continue to see assets roll into the book. It is an interesting market, though. You haven't seen as much.
Speaker Change: Distress and Loan Sales, as you would have expected.
Speaker Change: and a lot of the banks, the commercial banks that are working with borrowers and extending for small paydowns. I think borrowers are going to become significantly more excited about investing in their assets when they can see what the forward curve looks like today and did not look like this 30 days ago.
Speaker Change: So I think it's speaking for all people are where I mean
Speaker Change: I know I got negative leverage, but I can look out on the horizon and I see a 50% decline in supply in my market. I just have to get to 26%.
Barry Sternlicht: So I think, sadly, I don't think we'll be able to take back any of the assets that were brand new that we could buy at 65% of cost because that's what our loans were. But the good news is, I guess, that we will have an opportunity to refinance these people, and they'll support the assets, and they'll feel more inclined, and then, as I mentioned, the apartment markets are looking at a nearly 50%, in some cases, greater, decline in supply and today have record absorption. So there are some sessions in the market that's still a very healthy market. But we are on top of them. Thank you, and we'll take it.
Speaker Change: For the back half of 25, so.
Speaker Change: I think, sadly, I don't think we'll be able to take back any of the assets that were brand new that we could buy at 65% of cost, because that's what our loans were.
Speaker Change: But the good news is, I guess, that we will have an opportunity to refinance these people and they'll support the assets and they'll feel more inclined to continue to invest going forward. All of these markets in the US, the hotel market is okay. Here, I think you're seeing a
Speaker Change: They need to avoid some of the blue states, where the unions have been super strong. It's not so much the rents, it's the costs that are going up. In the industrial markets, they seem to be slightly re-accelerating here in the states, against the backdrop of a 70% decline in supply.
Speaker Change: and then.
Speaker Change: As I mentioned, the apartment markets are looking at nearly 50%, in some cases, greater decline in supply, and today have record absorption. So there are some concessions in the market that's still a very healthy market.
Speaker Change: Affordability of homes, this will change as rates come down, homes will get more affordable, it's probably start to accelerate.
Speaker Change: Of course, if the Fed doesn't relent and doesn't cut rates fast enough now, he could break the egg.
Speaker Change: And you can't use this weapon on this economy without...
Speaker Change: Seriously disrupting the service sectors.
Speaker Change: And I'm kind of a fan of Rick Reeder over at BlackRock, who actually said that keeping rates this high is creating $250 billion of interest income.
Speaker Change: For Savers, which they're spending on services, which is a part of the economy that continues to have too high inflation.
Speaker Change: So maybe he's right. Maybe this high rate is actually causing inflation and a more normal three or three and a half percent. So if we're in a more upward sloping curve of a normal economy, we actually take some pressure off the service of inflation that we see today.
Speaker Change: So in general, we're feeling pretty good about where we sit and we have problems in the loan portfolio. There isn't a lender in the United States that probably doesn't.
Speaker Change: But we are on top of them, and we're managing through them, and we look forward to it.
Speaker Change: Coming out the bright side of this storm, we can actually see it. I think for the first time we can see the sun.
Speaker Change: and the clouds breaking apart that is probably a federal rule. I didn't realize again they were just as late to lower rates as they were to raise rates.
Speaker Change: into the booming inflation we had in the pandemic era. So hopefully they'll be paying attention and they'll knock off this lag in rents and do like they do for oil and insurance and airlines.
Speaker Change: car prices and every other food prices, every other every other component inflation is real time except the rent.
Speaker Change: Thank you, and we'll take questions.
Speaker Change: Thank you. We'll now be conducting a question and answer session. In the interest of time, we ask that you please limit yourselves to one question and one follow-up. If you'd like to ask a question, please press Star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press Star 2 if you'd like to remove your question from the queue.
Speaker Change: For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please while we pull for your questions.
Operator: Our first question comes from the line of Rick Shane with J.P. Morgan. Please proceed with your question.
Speaker Change: Our first question comes from the line of Rick Shane with J.P. Morgan. Please proceed with your question.
Richard Shane: Thanks, everybody, for taking my question. Look, ultimately, credit is always a function of willingness to pay and ability to pay. And I'm curious, given the quality of the sponsors underlying your loan, whether the shift that you're looking at right now is about willingness to pay, and is this really sentiment driven, given the really radical shift in terms of forward rate expectations as we move into 25.
Rick Shane: Thanks everybody for taking my question.
Rick Shane: Look, ultimately credit is always a function of willingness to pay and ability to pay. And I'm curious, given the quality of the sponsors underlying your loans,
Speaker Change: If the shift that you're looking at right now is about willingness to pay and is this really sentiment driven given the really radical shift in terms of forward rate expectations as we move into 25.
Barry Sternlicht: I think it's too early to tell, you know, this just happened. So I mean, people are being constructive, but ourselves, as an equity player, when we're looking at restructuring or tearing down an asset, and we will, you know, we short end is super important for our borrowers. And I'd expect that this will, on the margin, help materially in their desires to stay alive till 25.
Speaker Change: And I'd expect that this will, on the margin, help materially in their desires to stay alive till 25. You know, I think, like I said, you can now see... Don't forget, like, you go back two months and heads of the major banks were saying no rate cuts this year at all. They're also saying some people, a small minority, were talking about rate hikes.
Barry Sternlicht: You know, I think, I think you can, like I said, you can now see, don't forget, like you go back two months, and heads of major banks are saying no rate cuts this year at all. They're also saying some people, a small minority, were talking about rate hikes. So this is the emperor has no clothes.
Barry Sternlicht: You've seen that this economy is super narrow. The GDP is being driven by data centers and spending on stuff that the average person doesn't feel. And so they don't feel like this economy is working for them. Their wages are marginally above inflation now, like 3% and falling. And none of us feel pressure in the job market the way we did in the craziness of the pandemic.
Speaker Change: And so they don't feel like this economy is working for them. Their wages are marginally above inflation now, like 3%, and falling. And none of us feel pressure in the job market the way we did in the craziness of the pandemic.
Barry Sternlicht: And immigration, both legal and illegal, has helped the picture on the employment side. And we'll see what happens. I mean, obviously, the election itself will have some consequences for the labor market if there are... Portions and things like that.
Speaker Change: And immigration, both legal and illegal, has helped the picture on the employment side. And we'll see what happens. I mean, obviously, the election itself will have some consequences for the labor market if there are deportations and things like that. So we'll have to see how that plays out.
Unknown Executive: So we'll have to see how that plays out. Rick, I'll add that our receipts of reserve are up to $380 million. So our optimism on rates, and it's really the last couple of weeks that this optimism has taken shape, as Barry spoke about, is not really reflected. We're still looking at every asset. There are a lot of knife fights out there, and we are not going to put optimism into our reserve expectations, and our receipts of reserve have still gone up. Basically, what we've seen in the last couple of weeks, if that holds, you could see things turn around, but we're not baking optimism into our financials today.
Unknown Executive: You know, if you have an office building and it's a seven six that yield, and it's 55 60%, you know, if you're looking at Please see the complete disclaimer at https://sites.google.com or at https://sites.google.com/policies, and how sure can you be at the... But all the private owners of real estate, including the household names you talked about, like the best borrowers, everyone has decided that there isn't a real estate private equity firm in the country that hasn't walked away from an office.
Speaker Change: You know if you have an office building and it's it's a seven six that yield and it's 55 60 percent least
Speaker Change: You know, if you're looking at...
Speaker Change: higher rates and negative returns as far as I can see you're not you're not going to invest in the office thing and that's the biggest issue in the office market are you going to put the TI in for the tenant that wants to move in and how sure can you be at the exit cap?
Speaker Change: And every office bar in the country is looking at their assets, maybe not their reach because they don't sell assets and they just want to keep them alive.
Speaker Change: But all the private owners of real estate, including the household names you talked about, like the best borrowers, everyone has decided that there isn't a real estate PE firm in the country that hasn't walked away from an office building.
Unknown Executive: I mean, everyone, ourselves, Blackstone, Brookfield, every single person has walked away from properties saying this is throwing good money after bad money, but the market will bifurcate exactly like Walmart, where the B's and C's had a tough time getting financing until the 12-caps, and the good balls are still getting financed in the CNDS market using 5 or 6 cap rates now on the balls, and they're actually performing. They're performing at a slow time.
Speaker Change: I mean everyone, ourselves, Blackstone, Brookfield, every single person has walked away from properties saying this is throwing good money after bad money.
Speaker Change: But the market will bifurcate exactly like the mall market did.
Speaker Change: where the B's and C's had a tough time getting financing, sell at 12 caps and the good balls are still getting financed in the C and D S market using...
Speaker Change: 5 or 6 cap rates now on the vols, and they're actually performing. They're performing as far as I was learning yesterday.
Unknown Executive: So the office markets will become obvious that the best buildings in the right cities are full, even in the United States, and they're commanding decent rent. One Dandy, for example, that's all green. And then there are buildings in New York that are completely empty. They're trading for $100 a foot because what was on the ground, these others are kind of like, you got to do something. It's just steel value and land value. That's all the residual scrap. These buildings have to come down. So, or find some use that nobody figured out. Different.
Speaker Change: So the office markets will become obvious that the best buildings and the best in the right cities are full, even in the United States, and they're commanding decent rent, One Dandy for example.
Speaker Change: And then there are buildings in New York that are completely empty that are trading for $100 a foot because one was on the ground, these others are kind of like, you got to do something. It's just, it's just steel value and land value. That's on the residual scrap metal. These buildings have to come down.
Speaker Change: So, or find some use, but nobody should get out yet.
Speaker Change: And it's going to be, in the office markets, it's going to be a while. It's going to take a time. And it's not just rates. I would say rates impact every other asset class in real estate. Office has a different situation in the U.S. It's different in Washington.
Unknown Executive: Look, it's an interesting distinction versus what you said about multifamily, where you basically said, hey, we'd be happy if everybody sold us everything at our basis right now. So I suspect there's going to be a pretty huge divergence between what you see going forward on the property. Huge, huge.
Unknown Executive: Huge, huge diversion, exactly.
Speaker Change: Huge, huge diversion. Exactly.
Operator: Thank you. Our next question comes from the line of Stephen Laws with Raymond James. Please proceed with your question.
Speaker Change: Thank you. Our next question comes from the line of Stephen Laws with Raymond James. Please proceed with your question.
Stephen Laws: Hi, good morning. I wanted to start with Originations.
Stephen Laws: Good morning.
Stephen Laws: I wanted to start with Originations. Noticed, you know, a pretty strong quarter.
Jeffrey DiModica: I noticed, you know, a pretty strong quarter, CRE loans up, you know, infrastructure loans up a good bit from Q1. Can you talk about the pace of Originations moving forward as you put your excess liquidity to work, and also where you're seeing the best returns? You expect to see opportunities elsewhere, maybe banks more willing to sell now that some of their investments aren't as underwater as maybe three or six months ago, and kind of how you think about the allocation of your excess liquidity into new investments.
Stephen Laws: Siri loans up, you know, infrastructure loans up a good bit from Q1. You know, can you talk about the pace?
Stephen Laws: of Originations moving forward as you put your excess liquidity to work.
Speaker Change: And also where you're seeing the best returns, you expect to see opportunities elsewhere, maybe banks more willing to sell now that some of their investments aren't as underwater as maybe three or six months ago, and kind of how you think about allocation of your excess liquidity into new investments.
Jeffrey DiModica: Barry, do you want me to start? We're seeing consistently higher returns in our energy infrastructure business, and the LTVs are moving in our favor as the demand for power has continued to increase. So I would say that we expect to continue to lean in there. As I look at our, and I believe the next couple of weeks, we're really going to see, with this rate move, the pipeline for CRE lending pick up even more. But our pipeline has, I would say, tripled over the last three quarters of actionable deals on the CRE side. So there are things to do.
Speaker Change: Barry, you want me to start? We're seeing consistently higher returns in our energy infrastructure business and the LTVs are moving in our favor as the demand for power has continued to increase.
Barry Sternlicht: I would say that we expect to continue to lean in there as I look at our, and I believe the next couple of weeks, we're really going to see with this rate move, we're going to see the pipeline for CRE lending pick up even more, but our pipeline has, I would say, tripled over the last three quarters of actionable deals on the CRE side.
Jeffrey DiModica: Things are becoming unglued and unfrozen, I should say, and I believe that we have the ability to put out a run rate that's probably 2 to 3x the run rate you've been seeing at accretive returns in a similar sort of 11.5 to 13% levered return on the CRE side and significantly higher than that on the energy infrastructure side. We've talked before about the fact that property is very difficult to buy today, with negative leverage and cash returns that are mid-single digits. You're betting too much on the Excel spreadsheet, allowing you to push rents up, et cetera. So we're probably not increasing much there. We haven't increased the RESI book.
Barry Sternlicht: So, there are things to do, things are becoming unglued and unfrozen, I should say, and I believe that...
Barry Sternlicht: We have the ability to put out a run rate that's probably 2-3x the run rate you've been seeing at accretive returns in the similar sort of 11.5-13%.
Barry Sternlicht: at the CRE side and significantly higher than that on the energy infrastructure side. We've talked before about the fact that property is very difficult to buy today with negative leverage and cash returns that are mid-single digits. You're betting too much on the Excel spreadsheet allowing you to push rents up, etc. So, we're probably not increasing much there. We haven't increased the resi book. There are some trades in the resi book that we think.
Jeffrey DiModica: There are some trades in the RESI book that we think are potentially getting closer to being interesting, so you could see us put money back to work there at some point. We have been buying a few CNBS B pieces where we think there's great value, and that's also supporting our CNBS Originations business. I think, uh, our regulatory team.
Barry Sternlicht: are potentially getting closer to interesting, so you could see us put money back to work there at some point. We have been buying a few CNBSB pieces where we think there's great value.
Barry Sternlicht: and that's also supporting our CMBS Originations business. The two likely places are going to be Energy Infra, where we're going to continue to lean in, and CRE, where we're seeing a bigger pipeline. Barry, I don't know what you would want to add to that.
Jeffrey DiModica: We have more than a billion dollars of actionable TRE loans that we can do. We're just balancing our needs to actually fix our assets up. Again, it's a whole bunch of other stuff, but we're doing it with a company that's materially more leveraged than we've been, 2.2 times, I think, than most of our peers. And also, it's a little nuanced, but we've cut our forward funding obligations from the peak of $3 billion to $1.2 billion.
Barry Sternlicht: Yeah, I think our origination came...
Barry Sternlicht: Thanks to more than a billion dollars of actionable CRE loans that we can do if we want to do them. We're just balancing our needs to actually fix our assets up.
Speaker Change: against a whole bunch of other stuff. But we're doing it with a company that's materially more leveraged than we've been, 2.2 times materially lower, I think, than most any of our peers.
Speaker Change: And also, it's a little nuanced, but we've cut our forward funding obligations from the peak of $3 billion to $1.2 billion.
Jeffrey DiModica: So we're much more, in much better shape there that we don't have to fund stuff that we don't. And that's sort of a nuance, but it's important to the overall picture of how we put out capital, I think.
Speaker Change: So we're much more, in much better shape there that we don't have to fund stuff that we don't want to fund.
Speaker Change: And that's sort of a nuance, but it's important to the overall picture of how we put out capital.
Jeffrey DiModica: I think, you know, transaction volumes are down like 70%, and the CMBS market's been the only place to finance real estate really of scale in the last six months. Most of our peers and ourselves have been cherry-picking around the edges of private debt, and some of the insurance companies are making some loans, and we have, So we've had a really hard time finding actionable deals. There's more liquidity or more trades or more, etc., etc., etc., etc., etc., etc., etc., etc. You know, it's very public.
Speaker Change: I think, you know, transaction volumes are down like 70% and the CMBS market's been the only place to finance real estate really of scale in the last six months.
Speaker Change: Most of our peers and ourselves have been cherry picking around the edges in private debt and some of the insurance companies are making some loans and we have our own private debt funds, but because there just aren't that many big transactions to finance, it just hasn't been that rich a population set.
Speaker Change: So we've had a really hard time finding actionable deals. There's more liquidity or more trades and more vending smaller assets. But if you want an apartment building, you didn't want to sell it. You know, it's very public that we lowered redemptions or
Jeffrey DiModica: We lowered redemptions, lower redemptions materially in our $25 billion estuary problem company, and that $25 billion, basically industrial assets, and we said we're not going to sell into a distressed market when we were convinced rates would come down. Unknown Executive Sarah Barcomb, Rina Paniry, Zachary Tanenbaum, Sean Murdock, and Adam Behlman will continue to sell assets. We're not like anyone else. Everyone was just like everyone else.
Speaker Change: Lower Redemption Materially in our $25 billion estuary property company.
Speaker Change: basically industrial assets and we said we're not going to sell them into a distressed market and we were convinced rates would come down and and add enormous liquidity and make our dividend more valuable and all those things hopefully seem to be will come true and then you'll continue to sell assets but
Jeffrey DiModica: Everyone else says, "I don't want to sell this, and there's no trade." There's nothing to refinance. No, there's no new loan. So, um, you know, you're, you're, you will exceed the market. The market, come on, I hate to be unglued, but let me correct it on stock. Transcription by https://otter.ai. Obviously, it has a different risk profile than the new chip that may or may not, or whoever could take him down and go into the way of the Dodo.
Speaker Change: We're not like anyone else, just like everyone else. Everyone else says, I don't want to sell this. There's no trade. There's nothing to refinance. No, there's no new loan. So, you know, you will exceed.
Speaker Change: The market come on, like I said, he unglued it and then he corrected it on stock.
Speaker Change: and there will be more transactions. You're seeing that already. I actually think you'll see a pretty strong buying appetite for this asset class. The volatility in equity markets reminds people of the compounding nature of real estate, the world's largest asset class. We're not going away. People will have to live somewhere. Most people will travel on vacations and this asset class is a material component of the world's capital markets.
Speaker Change: Obviously got a different risk profile than a new chip that may or may not live forever or could take it down and go into the way of the dodo bird.
Jeffrey DiModica: So it's a different aspect, and it'll find favor in a different market. And Stephen, to repeat something Rina said earlier about things becoming unfrozen, you know, we had 606 million of capital returned in Q2, but we had 620 million of capital returned just in July. So you're definitely seeing a trend with more capital starting to be returned, which means they have the ability to refinance assets away from us. And that is, you know, a good part of the unfreezing of the markets, but you're certainly seeing a trend line that is constructive. Yep.
Speaker Change: So it's a different asset class, and it'll find favor in a different market.
Stephen Laws: And Stephen, to repeat something Rina said earlier about things becoming unfrozen, you know, we had $606 million of capital returned in Q2, but we had $620 million of capital returned just in July . So you are definitely seeing a trend with more capital starting to be returned, which means they have...
Speaker Change: The ability to refinance assets away from us, and that is a good part of the unfreezing of the markets, but you're certainly seeing a trend line that is constructive.
Stephen Laws: Yep, appreciate the comments as a quick follow-up, you know, Barry's been pretty well covered, you know, slowing rent growth that is likely to be accelerated as the new supply slows. But last quarter, you mentioned something that was interesting that insurance costs across multifamily were coming in lower than expected. Can you maybe update us on that and generally kind of how you're seeing expenses run on the multifamily side?
Speaker Change: Appreciate the comments. As a quick follow-up, you know, Barry's been pretty well covered, you know.
Speaker Change: Slowing rent growth that will likely accelerate as the new supply slows, but last quarter you mentioned something that was interesting, that insurance costs across multifamily were coming in lower than expected. You know, can you maybe update us on that and generally kind of how you're seeing expenses run on the multifamily side?
Barry Sternlicht: Yeah, the pressures and multifamily expenses have come off a bunch. We were down here for over a year on insurance, property insurance, and I'm not sure that was across the United States or given our scale that, you know, we pull all our hundred-plus-billion-dollar assets together to get insurance. And I know that at least one other large person has similar insurance, but I can't speak to what small guys are borrowing because we don't think they have our insurance. So, but I would say overall, our experience has been good.
Speaker Change: Yeah, the pressures and multifamily expenses have come off a bunch. We were down here over a year on insurance, property insurance, and I'm not sure that was across the United States.
Speaker Change: or given our scale that, you know, we pool all our hundred-plus billion-dollar assets together to get insurance. And I know that at least one other large person has similar insurance, but I can't speak to what small guys are borrowing at. We don't think they have our insurance.
Speaker Change: So, but I would say overall our experience has been good, and you can see the, some of the expenses, like, it's interesting, I was looking at some of the SFR companies.
Barry Sternlicht: And you can see some of the expenses, like it's interesting; I was looking at some of the SFR companies. They're all over the place. And we own some of those family homes for rent too. So they are all over the place.
Speaker Change: They're all over the place, and we own some of that family parentals, too.
Barry Sternlicht: The states are in different positions with tax increases and real estate tax increases. So I do think you have obviously two states that are running a surplus, a big surplus, Texas and Florida, and two states running a massive deficit or three, Illinois, New York, and California. And so pressure on real estate taxes is truly different in the fiscal situation of each of the states. So, and in fact, Texas has lowered its taxes. They went in and lowered their taxes, which is, you know, it doesn't happen. It's like they should have a gong.
Speaker Change: They are all over the place, the states are in different positions with tax increases and real estate tax increases, so I do think you have obviously two states that are running a surplus, a big surplus, Texas and Florida, and two states running a massive deficit, or three, Illinois, New York, and California.
Speaker Change: And so pressure on real estate taxes is truly different in the fiscal situation of each of the states.
Speaker Change: So, and in fact, Texas lowered taxes, you know, they went in.
Barry Sternlicht: I think I've seen that once or twice in 35 years. So it's just state by state, you know. And even new construction is so all over the place. You know, the East and West Coasts have less construction, the Northeast and New York and California, because the growth was in the smile states, Texas, Georgia, Tennessee, Florida, and they got the bulk. Raleigh, North Carolina, they got the bulk of the new construction, and that's where people are moving.
Speaker Change: Lower the chagras, you know, it doesn't happen, you should have a gong, I think I've seen that.
Speaker Change: It's just state by state, you know, and there is even, even the new construction is so
Speaker Change: All over the place. You know, the east and west coasts have less construction. The northeast in New York and California, because the growth was in the smile states. The Texas, the Georgia, the Tennessee's and the Florida's. And they got the bulk, Raleigh, North Carolina, they got the bulk of the new construction. And that's where people are moving.
Barry Sternlicht: And so the rents are higher and materially different in some places. But I think one of our towns in Kentucky is up like 5%. I think DC is up materially. The other markets are down double digits in rents. So we talk about a national Rent Profile, but there's no such thing.
Speaker Change: And so the rents are higher and materially different in some places. But I think one of our towns in Kentucky is up like 5%. I think D.C. is up materially. And other markets are down double-digit in rents. So we talk about a national...
Barry Sternlicht: It's just an average of all the major markets. The problem, of course, that Powell has is that by reducing the supply of single-family homes and apartments so significantly, he's setting us up for another inflationary cycle in rent. And that's the negative of keeping rates for time and artificially reducing the supply of new homes, which has shifted market share dramatically to the major and national home builders away from smaller builders that can't get money because the regional banks don't want to lend. So it's created quite an interesting new dynamic in the markets, and it won't, it won't, it shouldn't.
Speaker Change: rent profile. There's no such thing. It's just an average of all the major markets. The problem, of course, that Powell has
Speaker Change: is that by reducing the stock of single-family homes and apartments so significantly, he's setting us up for another inflationary cycle in rents.
Speaker Change: and that's, you know, that's the negative of pounding keeping rates for time and artificially reducing the supply of new homes, which has shifted market share dramatically to the major and national home builders away from smaller builders that can't get money because the regional banks don't want to lend to them.
Speaker Change: So he's created quite an interesting new dynamic in the markets and it won't, it won't, it shouldn't
Speaker Change: I mean, as an apartment owner, I'm hoping we get these big apartment rents, but as an American, he'll be late to the game again, if he does, if he keeps the way he's looking at...
Speaker Change: This is 400 PhDs coming up with a model that makes no sense, and if they keep this lag in the right component of inflation, they'll get to the end on the way up, so such is life.
Operator: Great. Appreciate the comments this morning. Thank you. Thanks, Stephen. Thank you. Our next question comes from the line of Don Fandetti with Wells Fargo. Please proceed with your question. Yes, you know commercial real estate's been hit so hard through this cycle, and as you talked about.
Speaker Change: Great, appreciate the comments this morning. Thank you. Thanks, Stephen.
Speaker Change: Thank you. Our next question comes from the line of Don Fandetti with Wells Fargo. Please proceed with your question.
Speaker Change: Yes.
Don Fandetti: You know, commercial real estate's been hit so hard through this cycle, and as you talked about, Barry, kind of unintended consequence. When the Fed does cut, are you thinking that this is sort of a trickle of capital coming in, or do you see more of a meaningful sort of shift in sentiment and cap rates, where a lot of players might be just kind of waiting to get confirmation of cuts?
Barry Sternlicht: The equity side of real estate is pretty complex. And, you know, the areas of the world that were investing heavily in real estate funds, let's say the Middle East, with the position of oil and some other issues back home, they're a little less on the margin. They're still investing, but I think not at the pace they were before, as domestic needs have overwhelmed some of their national desires to invest offshore.
Barry Sternlicht: The equity side of real estate is pretty complex, and the areas of the world that were investing heavily in real estate funds, let's say the Middle East,
Speaker Change: With the position of oil and some other issues back home, they're a little less on the margin. They're still investing, but I think not at the pace they were before.
Barry Sternlicht: I think the Koreans and the Southeast Asians who are major players in the markets, I think they'll be induced to invest more heavily. And the U.S. market, I'm talking about the institutional market, will depend on what the stock market does. If the stock market craters, obviously, the denominator and the portfolio allocations come into play, and they'll be overweight in the property sector. So I do think you'll see individuals with high net worths, and they're a major force in the market for real estate. But in fact, through this entire cycle, people were most likely buying individual properties with no competition from families, and they were saying, I'm owning this at a six or seven. Yeah, I know that.
Speaker Change: domestic need to overwhelm some of the international desires to invest offshore.
Speaker Change: I think the Koreans and the Southeast Asians who are major players in the markets, I think they'll be induced to invest more heavily.
Speaker Change: And the U.S. market, I'm talking institutional market, will depend on what the stock market is. If the stock market craters, obviously the denominator and the portfolio allocations come into play, then they'll be overweight in the property sector. So I do think you'll see individuals show up and high net worths, and they're a major force in the market in real estate. But in fact, through this entire cycle, the people most likely buying individual properties with no competition with families.
Barry Sternlicht: But I could never get it in a better market, and I'm buying it for 30 years. So you've seen guys, you know, add real estate to their high net worth. And you're talking about many institutions.
Speaker Change: and and they were saying I'm owning this at a six or seven yeah I know like but I could never get it in a better market and I'm buying it for 30 years
Speaker Change: So you've seen, you've seen guys, you know, add real estate, build their high net worth, and you're talking many institutions. Some of these people have enormous balance sheets, so...
Barry Sternlicht: Some of these people have enormous balance sheets. So, on the whole, I'd say there's a ton of dry powder, and there's enough money there to propel the markets higher and create tremendous demand. The REITs will probably, as you can see, the stocks are rising. They may get back into the acquisition business. And I'd expect that by the time some of the dry powder is used up, the buckets will be refilled, and there'll be more money coming to the asset class. We're always competing as an asset class against other asset classes.
Speaker Change: On the whole, I'd say there's a ton of dry powder and there's enough money there to propel the markets higher and create tremendous demand. The REITs will probably, as you can see, the stocks are rising, they may get back into the acquisition business.
Speaker Change: And I'd expect that by the time some of the dry powder is used up, the buckets will be refilled and there'll be more money coming to the asset class. We're always competing as an asset class against other asset classes.
Barry Sternlicht: You know, you have six stocks carry the stock market this year, so, I mean, if you're in them, you're up a lot, and if you weren't in them, you weren't up that much, so, you know, anything that, it's like, okay, we're boring, we produce a 10, 11% consistent return, which, of course, meets every actual need of every institution in the United States, every endowment, but it's not, we're not venture, so, you know, I think Troubles and other asset classes throughout my career have always helped real estate, and they come back, you know, it gets a bid again, and real estate's going to get a bid again. The office market's going to work itself out, and it's unbelievable the federal government hasn't gone back to work, you know, Washington's decimated, and, you know, it's like, they haven't mandated workers to come back to the office in Washington, D.C., it's something.
Speaker Change: you know you have six stocks carry the stock market this year. So I mean if you're in them you're up a lot and if you weren't in them you weren't up that much so you know that any anything that
Speaker Change: It's like, okay, we're boring. We produce a 10-11% consistent return, which of course meets every actual need of every institution in the United States.
Speaker Change: Every Endowment.
Speaker Change: But it's not, we're not Venture.
Speaker Change: You know, I think troubles in other athletic classes throughout my career have always helped real estate.
Speaker Change: And then I come back to, you know, it gets a bit again, and I don't know if it's going to get a bit again.
Speaker Change: The office market is going to work itself out, and it's unbelievable the federal government hasn't gone back to work. Washington has been decimated. And, you know, it's like they haven't mandated workers to come back to the office in Washington, D.C. It's something.
Barry Sternlicht: So, you know, that's not the case in Miami, where the READ is based, and we have 80% occupancy, physical occupancy in office buildings today; people are back in the office. But it's not true in L.A. or San Francisco or Boston, and we'll see. A good recession will change a lot of things, I think, on the office front. So, I mean, I think people will go back to the office. I just think we're better together.
Speaker Change: So, you know, that's not the case in Miami where the READ is based and we have 80% occupancy, physical occupancy in office buildings today, people are back in the office.
Speaker Change: But it's not true in L.A., or San Francisco, or Boston, and we'll see. A good recession will change a lot of things, I think, on the office front. So, I mean, I think people will go back to the office.
Speaker Change: I just think we're better together. Thanks.
Operator: Thank you. Once again, as a reminder, if you would like to ask a question, please press star one on your telephone keypad. For participants using speaker equipment, and may
Operator: Thank you. Once again, as a reminder, if you would like to ask a question, please press star 1 on your telephone keypad. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key.
Speaker Change: Thank you. Once again, as a reminder, if you would like to ask a question, please press star 1 on your telephone keypad. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys.
Operator: Our next question comes from the line of Jade Rahmani with KBW. Please proceed with your question. Thank you. Can you give any update on Starwood's solution?
Speaker Change: Our next question comes from the line of Jade Rahmani with KBW. Please proceed with your question.
Jade Romani: Thank you. Can you give any update on Starwood Solutions? Have you gotten any traction with that? And just the CNBS market, you know, your comments about the banks.
Jade Romani: I see that market as having the potential to be meaningfully bigger in size post all of this than it was with the banks shrinking. Do you agree with that and do you see an opportunity to meaningfully grow both the conduit and the special servicer?
Jade Rahmani: Yeah, thanks, Jade. We've had our first couple of clients and solutions, the revenue is still fairly small, but we are talking to potential big players on the government side in a number of ways about potentially helping out there. And those could be the needle movers that we're really playing for. And we'll keep you posted as that goes.
Speaker Change: Thanks, Jade. We've had our first couple of clients and solutions. The revenue is still fairly small. We are talking to
Speaker Change: the potential big players on the government side in a number of ways about potentially helping out there and those could be the needle movers that we're really playing for and we'll keep you posted as as that goes. I think we've had
Speaker Change: something like 300 meetings in solutions, and it is starting to grow. So that is good. I would say on the CMBS side, it's been a really interesting market. The banks are very happy to do agent business like CMBS.
Unknown Executive: I think we've had something like 300 meetings on solutions, and it is starting to grow, so that is good. I would say on the CMBS side, it's been a really interesting market. The banks are very happy to do agent business, like CMBS, that comes on and leaves their balance sheets fairly quickly. They're less, they're more reticent to do portfolio loans. So I don't think that the large banks have pulled back, and the smaller banks were never big CMBS conduit originators.
Speaker Change: that comes on and leaves their balance sheet fairly quickly. They're less, they're more reticent to do portfolio loans. So, I don't think that the large banks have pulled back and the smaller banks were never big CMBS conduit originators. So.
Speaker Change: Our conduit originations pace of a billion and a half or two billion a year probably maintains in what is today still a smaller market than what it has been.
Speaker Change: We've seen a shift in the CMBS market. You know, you had a significant bid for five-year loans. Investors at yesterday's higher rates did not want to lock in.
Unknown Executive: So our conduit originations pace of a billion and a half or 2 billion a year probably remains in what is today still a smaller market than it has been. We've seen a shift in the CMBS market. You had a significant bid for five-year loans because investors at yesterday's higher rates did not want to lock in 10 years of a high interest rate.
Speaker Change: 10 years of a high interest rate and so they really pushed to five-year loans. Those five-year loans are available on the fixed-rate side through insurance companies. You're seeing a lot of insurance company growth in five-year fixed-rate loans and the CMBS market has become probably 80% five-year loans. That was 10% a couple of years ago. So the
Unknown Executive: And so they really pushed to five-year loans; those five-year loans are available on the fixed rate side through insurance companies; you're seeing a lot of insurance company growth in five-year fixed rate loans. And the CMBS market has become probably 80% five-year loans; that was 10% a couple of years ago. So the borrowers have moved in the curve, we're very willing to provide that capital, it's a little bit of a different B piece that ends up coming out, it's a higher dollar price B piece that has less time to accrete back to par. But it is something that is moving at similar rates to where they were over the last couple of years.
Speaker Change: The borrowers have moved in the curve. We're very willing to provide that capital. It's a little bit of a different B-piece that ends up coming out. It's a higher dollar price B-piece that has less time to accrete back to par. But it is something that is moving at similar rates to where they were over the last couple of years. So with the B-piece buyer in place and demand for five-year, we do expect five-year CMBS originations to continue to grow as a percentage.
Speaker Change: And, you know, with rates coming in here, I think you will see an increase over the coming couple of months on a lot of things that have been pent up. People have refinancings coming up. They're willing to move now as they see the lights of the eyes of a 3.70 or 3.80 10-year note. And that's going to bring things back in. Your spreads are a little bit wider in the last week as rates made this move, but that will settle in if we go back to yesterday's spreads at today's interest rates. I think the CMBS market picks up a bit. As I said in my opening remarks, we've made more money in the first six months this year than we did all of last year. And last year was a decent year. Part of that is spreads have been tightening. But I think that our place in that market where we write smaller loans, 10 to 12 million dollar loans, is probably...
Unknown Executive: So with the B piece buyer in place and demand for five-year CMBS loans increasing, we do expect five-year CMBS originations to continue to grow as a percentage. And you know, with rates coming in here, I think you will see an increase over the coming couple of months on a lot of things that have been pent up. People have refinancings coming up, they're willing to move now as they see the lights of the eyes of a 370 or 380 10 year note.
Unknown Executive: And that's going to bring things back to your spreads are a little bit wider in the last week as rates made this move, but that will settle in if we go back to yesterday's spread and today's interest rates. I think the CMBS market picks up a bit. As I said in my opening remarks, we made more money in the first six months of this year than we did all of last year, and last year was a decent year.
Speaker Change: [inaudible]
Unknown Executive: Part of that is that spreads have been tightening. But I think that our place in that market, where we write smaller loans, 10 to $12 million loans, is probably still the place where we will play. We have a couple of larger loans in the pipeline, but we sort of prefer the smaller mid-market loans there. And that is something that I think could get up to two or two and a half billion dollars, but it's probably not likely much bigger than that.
Unknown Executive: And the overall CMBS market probably won't grow significantly, although a rate move like this will move forward a bunch of supply. So we're optimistic that that business will continue to perform well. Yeah, I think the CMBS market is gonna grow. But the thing is, for borrowers, it doesn't work for transitional loans, they have to be cash-flowing assets, and they also have to be a certain scale to make them worthwhile.
Speaker Change: I think the CMBS market is...
Speaker Change: who's going to grow in size. But the thing is, for borrowers, it doesn't work for transitional loans. They have to be cash-flowing assets, and they also have to be of a certain scale to make them worthwhile, given the cost.
Unknown Executive: Transaction keys, so. Transaction keys, so. Transaction keys, so.
Unknown Executive: Well, private loans will always sit alongside the NDS. Yeah, I do think I've been remarking on some of the yields on that, which I think have been quite, very tight and I, but it's been the only way to finance that large portfolio. At this point, they're happy to act as conduits, but they're not happy to have us there. There's a lot of pressure from the OTC as we've been, 2 years, two and a half years to reduce the real estate hasn't helped anything, especially us and other borrowers in our sector who, like now, who are going to take you out and we'll take you out alone, www.starwoodproper So, you know, when things are really safe, there's money for it today. And I think this sea change has to be a heat change in real time with a lot of issues.
Speaker Change #100: The Borrowers of the Transaction Fees. The private loans will always sit alongside the TNDS executions. I do think I've been remarking on some of the...
Speaker Change #100: Some of the deals done, I think, have been quite aggressive in the CMBS market, both in coverage ratios and...
Speaker Change #100: I'm very tight and I, but it's been the only way to finance that large portfolio is really through the banks, as Jeff pointed out, they're happy to act as conduits, but they're not happy to have this stuff sit on their balance sheets.
Speaker Change #100: They're under a lot of pressure from the OCC, as they've been for two years, two and a half years, to reduce their real estate exposure, which hasn't helped anything, especially...
Speaker Change #101: with us and other borrowers in our sector who would like to get refinanced out, who's going to take you out? And who takes you out of an office loan today?
Speaker Change #101: You know, it's like, who's going to finance it?
Speaker Change #101: I think I when I mentioned the markets, I didn't talk about the debt markets for those asset classes. I mean, obviously, a Fannie and Freddie still in the apartment market, but like in the motel market.
Speaker Change #101: You're seeing loans 400 over, 450 over, those are loans we want to do, and they're not, as in a borrower wants to borrow that, but if you have a very stable cash flowing hotel, we just refinanced and asked it at 240 over, you know, but I think it was like a
Speaker Change #101: I don't know if I remember correctly, it's probably a 12 or 13 day yield. So you know, when things are really safe, there's money for it today. And I think this seed change, and it has to be a seed change in the real estate markets.
Speaker Change #101: of a lower rate, almost a certain lower rate profile in the future, at least the near future, so next June, is gonna,
Unknown Executive: It is good for the whole industry and for the country. So you wouldn't want the regional bank to collapse. That wasn't, that wasn't, and they were a victim of the Fed. Three things benefit real estate. Treasury because they have to pay less interest expense on 34 trillion, 35 trillion, and the regional banks, whose every drop in rates is inequity. There's a triple header of wounded, will be better off. And I just hope you hurry.
Speaker Change #101: mended a lot of issues and be good for the whole industry and for the country, frankly. So you didn't want the regional banks to collapse. That wasn't, that wasn't, and they were a victim of the Fed. Three things benefit real estate.
Speaker Change #101: This is Treasury because they have to pay less interest expense on $34 trillion, $35 trillion of debt. And the regional banks, which every drop in rates is an equity infusion into their balance sheet. So there's a triple header of wounded ducks that will be better off. And I just hope he hurries.
Unknown Executive: And Jade, I'll add that on the solution side, you know, you saw this quarter. I think Rina quoted that our servicing portfolio increased by $2 billion, but we did have $3 billion transfer out. So we actually added $5 billion of servicing this quarter across six deals. And that's a big part of that as a result of the number of meetings that we've been having on the solution side, which opens the door for other businesses there.
Speaker Change #102: And Jade, I'll add that on the solution side, you know, you saw this quarter, I think Rina quoted that our servicing portfolio increased by $2 billion, but we did have $3 billion transfer out. So we actually added $5 billion of servicing this quarter across six deals, and that's a big part of that as a result of the number of meetings that we've been having on the solution side, which opens the door for other businesses there. And my last thing, when I did talk about CMBS before, I was talking about fixed rate conduit and not SASB. Certainly there will be growth in SASB. We're seeing growth in SASB. I think that's what Barry is speaking to as well, and I would expect that to continue.
Unknown Executive: And my last thing, when I talked about CMBS before, I was talking about fixed-rate conduit and not SASB. Certainly, there will be growth in SAASB. We're seeing growth in SAASB. I think that's what Barry is speaking about as well. And I would expect that to happen.
Barry Sternlicht: Thank you. We have reached the end of our question and answer session. I'd like to turn the call back over to Barry Sternlicht for any closing remarks.
Speaker Change #102: Thank you. We have reached the end of our question and answer session. I'd like to turn the call back over to Barry Sternlicht for any closing remarks.
Barry Sternlicht: I thank everyone for joining us today. It was interesting. We don't often have that much to talk about, but it was, I think.
Barry Sternlicht: So I thank everyone for joining us today. It was interesting. We don't often have that much to talk about, but it was, I think...
Barry Sternlicht: We're very happy, given all the issues that the industry's faced, we're pretty happy we are. And again, I thank our shareholders, the board, and our really hardworking team for executing through this really difficult time. We had nothing to do with it. And I'm optimistic about our future, and I look forward to getting all the cylinders working again. So full voice, and continue to provide returns for our shareholders. Thank you so much.
Barry Sternlicht: We're very happy, given all the issues that the industry's faced, we're pretty happy we are. Again, I thank our shareholders, the board, and our really hard-working team for executing through this really difficult time.
Barry Sternlicht: We had nothing to do with. And I'm optimistic about our future, and I look forward to getting all the cylinders working again. So, pull forth and continue to provide outstanding returns for our shareholders. Thank you so much.
Operator: Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.
Speaker Change #103: Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.