Billionaire Barry Sternlicht is convinced the real estate market will rebound with just a bit more time. Many investors in his US$10 billion ($13.52 billion) Starwood Real Estate Income Trust aren’t so sure — and want their money back now.
That tension, between Starwood Capital Group’s chief executive who hates the idea of selling properties at their lows and investors who hate the idea of having their money trapped, reached a tipping point on May 23. The vehicle, known as SREIT, took the drastic step of further tightening limits on shareholders’ ability to pull money, in an effort to preserve liquidity and stave off asset sales.
With redemption requests mounting and just US$752 million in available liquidity at the end of April, the clock was ticking for SREIT to make a move. The new restrictions, which cap monthly withdrawals at 0.33% of net asset value — which would have been about US$33 million in April — are much more narrow than the previous 2% limit. Starwood will cut its management fees while the measures are in place, which the firm expects will be six to 12 months.
“This was a very hard decision to make, but having managed through six major downturns over our 30-year history, we believe we are making the best decision for all shareholders,” Sternlicht, 63, said in an emailed statement. “We anticipate the real estate markets are bottoming and will continue to improve from here, so further leveraging the vehicle or selling our portfolio’s assets to meet monthly redemptions would negatively impact all investors.”
SREIT’s move is the latest indication that commercial real estate woes are far from over. One measure of values was down 21% in April from the peak in March 2022, before the Federal Reserve started rapidly hiking rates.
Property owners responded by seeking loan extensions or cobbling together other liquidity plans in a time-honored real estate strategy called extend and pretend. But the recent pushback in rate-cut expectations means that investors such as Sternlicht are having to write new chapters to the industry playbook.
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“They were wrong this year about rates coming down,” said Jeff Langbaum, an analyst at Bloomberg Intelligence. “This stretches out their liquidity in hopes that eventually, they’ll be right.”
The pain, meanwhile, continues to ripple out. Investors in top-rated bonds backed by commercial real estate debt are getting hit with losses for the first time since the financial crisis. A Los Angeles landlord sold the city’s third-tallest office tower for 45% less than its price about a decade ago.
Stemming outflows
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In SREIT’s case, the situation has been exacerbated because higher rates give investors new ways to earn similar yields on much more liquid assets, making real estate less attractive. Still, the trust says that 80% of its investors have never redeemed and the moves to stem outflows will help maximise value for existing shareholders.
Limiting redemptions was a better option than forcing asset sales in a bad market, and cutting its fee helps align management’s interests with investors, said Kevin Gannon, chief executive officer of Robert A. Stanger & Co. SREIT’s competitors may take similar actions, he said.
“Being the first one to do it is tough,” Gannon said. “But it’s logical. Investors will get liquidity a little bit slower.”
Sternlicht is no stranger to distressed markets. He founded Starwood Capital in 1991, buying up heavily discounted apartments in the aftermath of the savings and loan crisis and built the firm into a real estate behemoth with about US$115 billion in assets.
SREIT is a newer addition, launched in 2018 amid a wave of similar offerings from Blackstone Inc. and KKR & Co. to give retail investors exposure to commercial property through nontraded vehicles. In the low-interest rate period that followed, the trusts became massive players, snapping up warehouses, apartments and Las Vegas hotels.
The cycle flipped in the middle of 2022. SREIT and its competitors faced mounting repurchase requests, pushing the firms to enforce limits on redemptions and sell assets to create liquidity.
One rival, Blackstone Real Estate Income Trust, also turned to asset sales when under pressure, and even struck a deal with the University of California for an investment. BREIT enforced a 2% cap on redemptions starting in late 2022, but said in March that withdrawal requests had eased and fallen below that key threshold.
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Worsening liquidity
Starwood’s vehicle reached a turning point in October 2022, when its redemption requests exceeded the 2% threshold. All of those requests were fulfilled, but the trust left some requests unmet a month later.
Redemption pressure eased at the end of last year when it appeared the Fed was getting ready to cut interest rates. Shareholders requested just US$314 million in December 2023, down from a peak of US$715 million in January of that year. But with the economy roaring, policymakers started warning that rate cuts might not happen as soon as previously forecast, complicating the outlook for real estate.
That encouraged investors to keep pulling out money. SREIT paid out more than US$700 million over the first four months of the year, drawing heavily on a line of credit. By the end of April, it had US$752 million in available liquidity, including cash, credit and real estate securities. With the outlook for interest rate cuts uncertain, the fund decided to limit redemptions and wait for “sunnier skies”.
“There is plenty of ‘dry powder’ to purchase real estate, but much of it remains on the sidelines as bid-ask spreads remain elevated, the sign of market not functioning properly,” Sternlicht and SREIT CEO Sean Harris said in a letter to shareholders.
