As a REIT investor, I got to take in whatever perspective that I can come across about the supply and demand of properties going forward.
Our newest associate adviser have not even started work in the company but he has alerted me to this pretty good interview by the chairman and CEO of Starwood Capital Group.
Some of these people are motivated by their personal interest about the issue, so what they tell us might be a little or very bias.
I think this is a pretty balanced interview.
Starwood Capital group is an investment firm that was born out of the US Savings and Loans Crisis in 1991.
The failed banks had to let go of their properties and Barry Sternlicht raised $20 million from a few New York families to fund the purchases of these properties. Today, they hold $60 billion worth of assets.
I have always associated the Starwood name with hotels but turns out as a group entity, Starwood operates more as an investment firm doing all sorts of deals trading properties, improving portfolio and bringing in investors.
“Starwood Capital sought to acquire well-located real estate assets at a discount to replacement cost that has the potential to benefit from improving fundamentals. In so doing, we have invested in a wide range of distressed securities and non-performing loans, single assets, portfolios of assets, and companies.”
As the head of the firm, the chariman should have a pretty good view about how the state of affairs after Covid-19.
Here is the interview:
The biggest discussion point was on one of the most densest cities in United States: New York.
- In the hotel segment, the cities which typically thrive on big conventions like Chicago, New York, New Orleans will be the most affected. That will take a while to come back
- Zoom meetings will cut the rate of growth (the finance side of him speaking. This will affect the valuations of the properties)
- The office will have less of an impact. Going to the office is an experience that will not go away. Companies will take less space.
- 20 years ago, office spaces have gone denser from 225 sqft to 300 sqft per person. Likely, the density will go back the other direction
- The retail shopping center is the most hard hit. A lot of the retailers are upping their online game and have done really well. So those shopping centers that depend on tenants are going to get a hard hit. This is not an easy asset class to be in.
- Single-family housing is strong
- Barry believes a lot is how the employment will be going forward. If we stay at 20% unemployment for a prolonged period, this will have an impact on demand and rent, which will affect property prices
- New York has a lot of things not going for it
- Covid-19 and the protests in a very dense environment have worsened the problem
- Tax rates are high
- Strong unions mean that generally, the cost of doing business is high relative to other places in the United States.
- If you tax the rich, the rich leaves, less tax revenue, it places more pressure on those who stay, and that further exacerbates the problem.
- In the past few years, the more active players are less of the financial firms but the communications and internet companies. The reason they come to New York is that the talents want to be in New York. If the talents had a change in perspective in the future, then the demand for properties may shift accordingly.
- There is huge pressure on real estate. Rents could drop 25% and expenses could climb 25%
- However, every foreign investor wants to own properties in New York
- Just before Covid-19, a law was passed that if you put in investments to the property to improve it, you are not allowed to charge additional rent for it. Effectively, this is rent control and this disincentivizes owners to improve their property. The result of this, as seen in other areas is that the place becomes more and more run down.
- WeWork was New York’s largest tenant. That likely means this segment in New York will not grow any time soon.
- Starwood Capital prefers to add assets in the Red states (Republican) primarily because they are growing, they are adding people, lower in taxes
- Shared office space makes sense but the valuation of the companies may be wrong. WeWork makes good money from countries like Tokyo and Singapore and it makes less sense in lower-tier cities
- WeWork is paying the rent in the majority of Starwood’s properties
- Barry thinks that WeWork can make pretty good money. He cites the example of their London space which they leased from Starwood Capital. They charge tenants $160 and after netting their cost they earn $130. They then pay Starwood $65.
- Retail is damn tough
- Properties are bought when rent is $10,000 PSF and if tenants ask to pay the rent at $3,000 PSF, the value of the property will fall so much that it will go back to the financier. So landlords would rather keep the property empty
- It is very very difficult to underwrite retail properties because you got tenants but you do not know what is the rent that they will charge.
- It will take some time before they reached equilibrium
- Amazon is the pandemic of retail. They practice predatory pricing (sell their products below the cost of goods) and in some other industries, this would have to be regulated.
- Barry thinks that there will be a wave of distressed assets coming.
- The FED just encouraged the banks to work with the borrower but they are not doing it
- 1/3 or 1/4 of hotels in New York will go bankrupt
- Hotels catering to high-end clients are not much affected
- Hotels that build their business around conventions are going to be severely affected.
Overall, I think there is nothing new here. What will be difficult is that it is difficult to see demand and supply. This translate to the stabilized rent. And that translate to the valuation.
There will be moderation but we are not sure how the terminal state will be.
This is not unique to real estate but other business segments as well.
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