Starwood REIT Tightens Redemption Limits Amid Commercial Real Estate Market Pressures

Key Takeaway

• Starwood REIT tightens redemption limits to 0.33% monthly and 1% quarterly amid liquidity concerns, down from previous 2% and 5%.
• Commercial real estate market faces distress; top-rated bonds backed by commercial real estate debt see first losses since the financial crisis.
• Rising interest rates impact real estate investments, with notable defaults like Crystal Asset Management's $49 million loan now delinquent.

Starwood Real Estate Income Trust Limits Redemptions

Starwood Real Estate Income Trust (SREIT), a $10 billion fund managed by Barry Sternlicht’s Starwood Capital Group, has announced tighter limits on investor redemptions to preserve liquidity. According to a filing on Thursday, SREIT will now cap monthly redemptions at 0.33% of its net asset value and 1% per quarter. Previously, the trust allowed withdrawals of up to 2% of net asset value per month and 5% per quarter. These new restrictions are expected to last between six months to a year.

In a letter to shareholders, Sternlicht and SREIT CEO Sean Harris explained the rationale behind the decision: “As a fiduciary to our stockholders, we cannot recommend being an aggressive seller of real estate assets today given what we believe to be a near-bottom market with limited transaction volumes, and our belief that the real estate markets will improve.” To mitigate the impact on investors, Starwood Capital Group will reduce its management fees while the new limits are in place.

The move reflects the broader challenges facing the commercial-property market amid higher-for-longer interest rates. SREIT and competitors like Blackstone Real Estate Income Trust have faced increased redemption requests since the second half of 2022. In October 2022, SREIT’s redemption requests exceeded the 2% threshold, and while all requests were fulfilled that month, some were unmet in subsequent months.

Commercial Real Estate Market Pressures

The commercial real estate market is showing signs of distress, with top-rated bonds backed by commercial real estate debt experiencing losses for the first time since the financial crisis. Investors in the AAA portion of a $308 million note backed by the mortgage on the 1740 Broadway building in midtown Manhattan received less than three-quarters of their original investment after the loan was sold at a steep discount. According to Barclays Plc, this is the first such loss of the post-crisis era, with all five groups of lower-ranking creditors being wiped out.

Lea Overby, a CMBS strategist at Barclays, commented, “Now that we’ve seen the first commercial mortgage-backed securities get hit, other AAA bonds are bound to see losses. These losses may be a sign that the commercial real estate market is starting to hit rock bottom.” The share of delinquent office loans packaged into commercial mortgage-backed securities reached 6.4% in April, the highest since June 2018, according to Moody’s Ratings.

The 1740 Broadway building, bought by Blackstone Inc. in 2014 for $605 million, faced significant challenges after its main tenant, L Brands, exited the tower in 2021. Despite Blackstone’s efforts to modernize the building, finding new tenants proved difficult, leading to a default on the loan in 2022. The building was eventually sold to Yellowstone Real Estate for roughly $186 million, resulting in significant losses for bondholders.

Rising Interest Rates Impact Real Estate

Rising interest rates have also affected other real estate investments. Crystal Asset Management, a Beverly Hills-based apartment owner, is delinquent on a $49 million loan tied to a multifamily property in Riverside County. The loan, originated by Arbor Realty Trust and packaged into a collateralized loan obligation pool, is now 30 days late. Crystal bought the property for $39.5 million in 2019 and secured a $48.7 million loan in December 2021 when interest rates were at record lows. However, the floating-rate loan has seen its interest rate rise from 4.2% to 9.5%, squeezing profits and making it difficult to service the debt.

Arbor Realty Trust has modified $1.9 billion in loans in the first quarter to stave off defaults, as many borrowers face similar challenges. At the end of March, the property was generating only 70% of the income needed to service the debt, down from 173% when the loan was first issued.

Management Quotes

• Barry Sternlicht, Starwood Capital Group:

  "As a fiduciary to our stockholders, we cannot recommend being an aggressive seller of real estate assets today given what we believe to be a near-bottom market with limited transaction volumes, and our belief that the real estate markets will improve."

• Barry Sternlicht, Starwood Capital Group:

  "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. 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."