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  • Emerging Real Estate Digest Writer

Big American Cities Facing a "Detroit Cycle" if Rates Remain High (WATCH)

On January 24, Barry Sternlicht was interviewed at the iConnections Global Lodging Conference where he discussed what he's seeing in the world of commercial real estate. Barry's voice matters because he is a co-founder (with Bob Faith) and CEO of Starwood Capital Group with $120 billion+ in AUM of mostly apartments and hotels.

On office-to-residential conversions in major American cities Barry stated:

"The federal government will come in with some credits to help people convert or tear down buildings and turn them into residential, which we desperately need. But] the cities are going to have a problem... the big blue cities that are not working... I don't know anyone [and] I haven't met anybody who thinks what's happening in San Francisco is good, you know? But it's not good. And then retailers leave and these cities become ghost towns. And we'll go through the Detroit cycle."

Part of what is going on here is Barry Sternlicht, like so many private equity managers, is stuck holding a large number of properties in short-term investment vehicles. Exits aren't possible at these valuations, at least not without taking large losses. Private equity will always spend the money they have raised from LPs, and scramble to make the numbers work if the theme comes under pressure. The incentives are unequivocally towards spending and raising capital. Forgoing investments means returning capital and fees, and a reduced likelihood of future funds being raised. This is why every smart LP knows that when you're dealing with Private Equity GPs it's "all gas and no brakes" after the investment is finalized.

At the same conference, Barry also discussed office issues plaguing America which he blames mostly on persistent remote working trends. On office globally he reminds the listener that:

"...there is a bright spot - the office situation is a completely US phenomenon. I just was in Munich last week, and rents in Munich are up 15%. The vacancy rate in Munich is 2% for Class A. In Seoul, Korea, it's 1%. In Tokyo, it's 4%... Everyone's back to work except for Americans. We've gone off the deep end. We don't show up for work, we don't apply for jobs, and we don't feel like we have to go back to the office."

Why is it that "everyone is back to work except for the Americans" Barry asked during a recent interview. Why is the trend seemingly isolated to American companies and workers?

We've always been told Americans are hard working, industrious, go-getters, and always willing to go the extra mile. Was that all a lie? Have Universities let us down in training the next generation of leaders?

Or do we blame the bosses? Have years of hiring and promotion policies based on everything except merit finally caught up to Americans. Have American companies become incapable of making decisions for the greater good if even a handful oppose, often on emotional and self-serving grounds?

Before the lockdowns 17% of jobs were remote. I don't believe Barry is suggesting the elimination of remote work, it's the return to the baseline of nearly 1 in 5 jobs as remote.

Barry also gives his two cents on interest rates and impact on valuations:

"We have a problem in real estate. In every sector of real estate, not just office, because of the 500 basis point increase in rates that was vertical...The office market has an existential crisis right now... it's a $3 trillion dollar asset class that's probably worth $1.8 trillion [now]. There's $1.2 trillion of losses spread somewhere, and nobody knows exactly where it all is... There are buildings in New York that were bought for $200 million... the loan was $100 million... and we [personally] thought it was worth $30 million. There's a building for sale right now in San Francisco. It was bought for $850 per sq ft. The loan was $450 per sq ft. They'll [probably] sell it for $250 per sq ft... that's $0.25 on the dollar...That would mean we lost three-quarters of the total asset class..."



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