Starwood Property Trust - Q3 2023

Transcript

Operator (participant)

Greetings. Welcome to Starwood Property Trust's third quarter 2023 earnings call. At this time, all participants will be in listen-only mode. A question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero from your telephone keypad. Please note, this conference is being recorded. At this time, I'll hand the conference over to Zach Tanenbaum, Director of Investor Relations. Zach, you may now begin.

Zach Tanenbaum (Director of Investor Relations)

Thank you, operator. Good morning, and welcome to the Starwood Property Trust earnings call. This morning, the company released its financial results for the quarter ended September 30th, 2023, 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. 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 statements.

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. Additionally, certain non-GAAP financial measures will be discussed on this conference call. Our 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.

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 am now going to turn the call over to Rina.

Rina Paniry (CFO)

Thank you, Zach, and good morning, everyone. This quarter, we reported distributable earnings or DE of $158 million or $0.49 per share. GAAP net income was $47 million or $0.15 per share. GAAP book value per share ended the quarter at $20.18, with undepreciated book value at $21.15. These book value metrics include $404 million or $1.29 per share of reserves related to our CRE and infrastructure lending businesses, including $15.8 billion of commercial loans, $2.3 billion of infrastructure loans, and $535 million of combined REO. Beginning my segment discussion this morning is Commercial and Residential Lending, which contributed DE of $207 million to the quarter or $0.64 per share.

In Commercial Lending, we had $762 million of repayments during the quarter, which outpaced fundings of $263 million. Subsequent to quarter end, we collected another $331 million in repayments. This includes $52 million from a non-accrual loan on a retail and entertainment asset in New Jersey, which represents 90% of the retail exposure in our loan portfolio. Because the loan is on cost recovery, any cash received is used to reduce basis. Our portfolio of predominantly senior secured first mortgage loans ended the quarter at $15.8 billion, with a weighted average risk rating of 2.9. Of the $600 million balance decline from prior quarter, $160 million was due to foreign currency fluctuations.

This was offset by the FX impact of our foreign-denominated debt, as well as our FX hedges, which together had unrealized gains totaling $153 million. As a reminder, we hedge 100% of our expected cash flow exposure on non-USD loans, including both projected principal and interest. Turning to CECL, we have previously discussed the third-party software we use to model our CECL reserve. That model in turn utilizes Macroeconomic Advisers for purposes of determining the Economic Outlook. In running our third-party model this quarter, we selected a more pessimistic outlook for our office loans, which increased our general reserve by $51 million, bringing our total reserve to $280 million, of which $177 million relates to U.S. office. When looking at our loan reserves, it is important to look beyond just our CECL reserve.

Some of our loans have been moved to REO, while some loans that are still on balance sheet have reported charge-offs. Neither of these appear in our GAAP CECL reserve, although both have already been reflected as a reduction to book value. When we include these components, our Commercial Lending reserves are 2.24% of our lending portfolio, which is at the median of our peers, despite our low office exposure. During the quarter, we placed one new loan on non-accrual, a $61 million mortgage and mezzanine loan on a multifamily property in Portland, Oregon, which Jeff will discuss. As of quarter end, our non-accrual loans and REO represented less than 4% of our total assets. Next, I will discuss our Residential Lending Business.

Our on-balance sheet loan portfolio ended the quarter at $2.5 billion, including $873 million of agency loans. We continue to be patient while the loans in this held-to-maturity portfolio repay. Despite our GAAP mark, these loans continue to prepay at par. We received $66 million of par repayments during the quarter and $180 million year to date. Lower prepay speeds continued to benefit our retained RMBS portfolio, which ended the quarter at $451 million. As a reminder, we fully hedged the interest rate exposure in this portfolio, with our hedges having a positive mark of $196 million at quarter end, after $25 million of cash receipts in the quarter. Next, I will discuss our property segment, which contributed $23 million of DE, or $0.07 per share to the quarter.

Of this amount, $14 million came from our Florida Affordable Housing Fund, where we rolled out the HUD maximum allowed rent levels discussed last quarter. A change in HUD's max rent calculation this year resulted in 3.8% of rent growth being deferred to 2024. This portfolio's 3.7% blended fixed and floating rate debt, with just under four years of average remaining duration, continues to be an asset and gives us ample time to wait for an opportune time to extend the debt in the coming years. Turning to investing and servicing, this segment contributed DE of $16 million, or $0.05 per share to the quarter. In our special servicer, our active servicing portfolio increased from $5.7 billion to $6.1 billion.

We continue to see loans transfer into servicing, with $700 million of new loan transfers this quarter, nearly two-thirds of which were office. Our named servicing portfolio declined to $101 billion in the quarter, with new assignments of $2.4 billion, offset by $3 billion in maturities. In our conduit, Starwood Mortgage Capital, we completed two securitizations totaling $63 million, at profits consistent with historic levels. We expect to see higher volumes from this business in the Q4 and into 2024 as loan maturities pick up. And on the segment's property portfolio, we sold two assets in the quarter for a total of $35 million in proceeds, resulting in a net GAAP gain of $11 million and a net DE gain of $6 million.

Concluding my business segment discussion is our infrastructure lending segment, which contributed DE of $9 million, or 3 cents per share to the quarter. The majority of our investing this quarter was in this segment, where we entered into $444 million of new loan commitments. Fundings on these new loans of $351 million outpaced repayments of $265 million, bringing the portfolio up slightly from last quarter to $2.3 billion. On the CECL front, we charged off $11 million of our specific reserve related to a legacy GE investment that we discussed last quarter, which resulted in a corresponding DE loss. I will conclude this morning with a few comments about our liquidity and capitalization.

Our liquidity position remains strong at $1.1 billion after the $300 million repayment of our unsecured notes at maturity on November 1. This does not include liquidity that could be generated through sales of our assets in our property segment or debt capacity that we have via our unencumbered assets and Term Loan B. As a reminder, 83% of our total outstanding on and off-balance sheet debt is non-mark-to-market, as is 91% of our commercial lending debt. With the repayment of our unsecured notes last week, we now have no corporate debt maturities until December 31, 2024. Our leverage remains low, with an adjusted debt to undepreciated equity ratio of just 2.42 times at quarter end, or 2.37 times after the repayment of our unsecured notes. With that, I'll turn the call over to Jeff.

Jeff DiModica (President)

Thanks, Rina. We've maintained very low leverage of just 2.4 turns today and invested in every quarter since our inception, including $650 million this quarter and $2.7 billion in the last twelve months. This quarter's originations were across business segments, but primarily in our very accretive, low loan-to-value energy infrastructure lending segment, with expected returns in the high teens. Despite higher interest rates today, many of our borrowers continue to execute their business plans, and loan repayments have continued to outpace our conservative expectations this year, giving us significant capital to accelerate our investing pace and/or continue to build our liquidity. Rina mentioned we are sitting on near record cash today.

Due to the accordion nature of our bank warehouse lines, we are able to deleverage our balance sheet with excess cash by paying these lines down, reducing our interest expense by an average of SOFR + 260 basis points today. This means for the first time in our history, we are saving and thus earning 8% on cash balances. When LIBOR was 25 basis points, we earned less than 3% on our cash, which created significant earnings drag if we didn't reinvest excess liquidity immediately. Earning an incremental 5% on our cash allows us to conservatively bolster our balance sheets with more cash in today's volatile interest rate environment, while creating very little earnings drag. We have $1.6 billion in loans financed today on bank lines at SOFR plus 275 basis points or higher.

As I've explained in the past, this relatively expensive bank debt is potentially an asset of the firm, as it sets us up to opportunistically replace that secured debt with unsecured debt in the future, should our unsecured borrowing spreads normalize to historic averages. We would then replace secured debt with unsecured bonds at little or no cost. Creating more unsecured debt as a percentage of total leverage at our company is a key metric, along with our already low leverage in achieving our long-term goal of receiving an investment-grade bond rating. As I mentioned, we were busy in our energy infrastructure finance business this quarter, committing to $444 million of new investments with a high teens return on equity.

We continue to believe this low loan-to-value business is our most accretive opportunity today and expect to continue to see outsized growth in this business line in the coming year. Massive demand for power and lack of competition for financing gas-fired power plants and midstream gas transmission and storage assets has allowed us to earn higher unlevered yields on better credits with better structures. Our asset spreads have increased, but our financing spreads have not risen in line with our other businesses, thus creating even more accretive levered returns for shareholders today. Our post-General Electric acquisition portfolio now makes up almost 90% of our SIF portfolio, with a high teens levered return and no realized losses to date.

In commercial lending, our five rated loans decreased by 27% to $555 million, or 2% of assets in the quarter, and our four rated loans increased by $284 million to $987 million, or 3.6% of assets, primarily due to the upgrade of the retail and entertainment loan in New Jersey that Rina mentioned, paid down by $52 million in October. We downgraded a $61 million multifamily loan in Portland to a five in anticipation of our taking control through a UCC foreclosure on the asset, at which time we plan to sell the property at our basis to an unrelated third party.

We also downgraded a $118 million office loan in California from a three to a four, as the loan went into payment default at the end of the quarter. This asset is 75% leased and produces almost 7% debt yield today, with a rapidly growing $50 billion market cap tenant expanding into one-third of the space and potentially more in the future. We are finalizing negotiations with the sponsor to give the asset runway to fund accretive leasing through 2024. Office remains our industry's most challenged asset class. We are happy to have cut our office exposure in half over the last few years, with loans on U.S. office comprising just 10.5% of our assets today.

Following the repayment at par of two B-quality office loans in Midtown Manhattan in the quarter, we now have no loan exposure to Manhattan office and no loan exposure to any asset class in San Francisco. 85% of our CRE loans have interest rate caps in place or are fixed rate loans not affected by rate increases, and another 6% have interest reserves or guarantees. So we have interest rate protection on 91% of our CRE loans today. Since COVID, we've reduced our exposure to construction loans and therefore to future funding obligations. Construction loans now comprise less than 10% of our funded loan book, the lowest in over 10 years. Pro forma for a senior loan payoff we expect in Q4, this decrease has reduced our future funding obligations on both construction and non-construction loans to just 4% of assets.

Having less future funding exposure and over a year until our next corporate debt maturity allows us to wait for the most opportune time to raise capital in the coming years, should we choose to go more aggressively on offense. In our residential lending business, we were able to offset lower prices on our loan book due to the rise in rates, with gains in our rate hedges and in the value of securities held from previous securitizations, which have outperformed as prepay speeds have gone down. In the quarter, we executed on our plan to move over $2 billion in residential loan collateral financed on bank lines to other money center banks, leaving us no regional bank counterparties, extending our facility durations, increasing potential advance rates, and most importantly, significantly lowering our borrowing spreads and costs.

Finally, this quarter in our REIT business, we are launching a third-party services business we will call Starwood Solutions. This team will solicit and execute on third-party fee-based services, including individual asset or portfolio evaluations, restructuring and balance sheet consulting, collateral management and surveillance, underwriting and due diligence for equity portfolios, loan portfolios, or securitizations, and a full spectrum of capital markets and investment consulting services. Starwood Solutions will partner with our 200+ professional team at REIT that together have worked out over 7,000 loans, totaling $88 billion in value over the 32 years they've been in this business. We are working with broker partners and engaging directly with CRE asset owners to provide these high value add services that we expect will create high multiple fee-based revenue for Starwood Property Trust shareholders in the future.

There has never been a better time to launch this vertical, one we hope will become our eighth business line. We are keen to continue to add fee-based business lines as a real estate investment and services business that continue to pull us away from a price-to-book valuation methodology. I would love to introduce anyone listening, brokers, owners, lenders, and consultants, to our team to discuss what we can do for you and your clients in more detail. With that, I will turn the call to Barry.

Barry Sternlicht (Chairman and CEO)

Thank you, Jeff, Rina, Zach, and good morning, everyone. Thanks for being with us. If I sound like I'm under the weather, I am home with COVID, so I might not be. I'm not sure anyone would call me coherent before, but I might be less coherent than I might normally be. I just some quick comments on the real estate markets. You know, as many of you know, I've been very critical of the Fed for a number of reasons, but the key one was the economy was slowing on its own, and the COVID stimulus package was being spent, and the shelves were being restocked, so there was no longer so too much money chasing too few goods. Now, you had less money and the shelves were full, and you can see that by retail sales.

What we missed in my forecast was the scale of the Bidenomics, the spending packages of the infrastructure bill, which has kept construction jobs flat, even though rates have risen 500 basis points. The delay in the travel business that supported the economy while other sectors kind of weakened. The CHIPS Act, Inflation Reduction Act, and of course, even the remaining money from the American Recovery Act have been enough to keep the public economy strong, while the private economy began to wilt. And I do think, as I've been very vocal about, that inflation is coming down. I think I've been saying that for months on TV. A third of inflation comes from rents, and rents were trending down, particularly in the apartment segment, which we have a front-row seat to.

So, rents are still positive, but they're not running 10% and 20%, which they were running when the Fed missed it. But they're up at 3% or 4% today. Just the move of the current Fed number is almost seven, seven for rents. It's coming down to 3%. Inflation falls below 2%, except for the wild card of oil prices, and I think we're all sort of scratching our head with oil around $80 with the situation in the Middle East. That's one that you scratch your head and you cannot forecast what might happen to inflation should there be disruptions to the oil supply. But I will say in general, I think you've seen the top in rates.

I think Powell and his crew are paying a little more attention to the delays in their own data. They actually mention it now. And actually, what's happened in the regional banking world and the contraction of credit, and the reduction of credit in the corporate world from the money center banks, will have a significant impact, though it's delayed, on this economy. So I think you have seen the top of rates. You saw this rapid move, 40 basis points in a 10-year, just last week. That supports the real estate complex. And I again, I'd say that real estate is the unintended consequence of a fight the Fed is fighting.

We didn't. You know, he's after inflation, but he's crushing other industries that are material to the U.S. government, like real estate, where significant capital gains help fuel the revenues to offset the increased interest expense of spending all this money on our $33 trillion of debt. So I also said the government really can't afford 5%. Almost $10 trillion of our $33 trillion of debt rolls the next 12 months. I think it's slightly more than that. It's like a third. So you have a $500 billion interest bill coming in very soon, and the current interest expense in the budget is absurdly low. It will climb probably closer to $1 trillion if he doesn't relent. And again, I just adore people who compare what he's doing to Volcker. Volcker had almost a negligible deficit.

He, he operated with a $200 billion dollar, not a $333 trillion dollar deficit. All this is important because it forms a framework of what we're doing and what the opportunity set is for us going forward. So one thing that's happened, of course. And, and one more thing about the deficit, the largest delta to the budget of February, March of this year, when they just announced the deficit would be $2 trillion, not $1.3 trillion, was the decline in receipts. It was a $170 billion dollar miss by the CBO, which is amazing, because if I had a if our guys were off by 40% on a number, I, I don't think they'd have their jobs.

We're applauding this guy, and he doesn't seem to be realizing what he's doing to the other side of the deficit equation, which is the revenue side. Obviously, they sold down their book. That created a $91 billion variance to their original forecast for the deficit, and then the $171 billion in receipts, interest expense was only, like, $100 billion off. So he was off, but he knew what he was doing, but they didn't forecast it properly. Anyway, what that's led to is a dramatic reduction in transactions in corporate M&A. Everything is down. Real estate transactions are way down 60% to 65%. That limits the number of opportunities we have to deploy capital and other players in our field.

But what's more interesting, of course, is that the regional banks, which have loaded up on $1.9 trillion of real estate debt, and the money center banks are getting tremendous pressure from the OCC and Powell's Federal Reserve group, the FDIC, to reduce their exposure to real estate. That has left us with probably one of the best lending environments, maybe the best lending environment since we started this firm back in 2009 in the GFC, again, when there was no credit. So there are really remarkable opportunities for private credit, and we hope that Starwood can position itself as the preeminent private lender in this space going forward, much the way other alternative managers have taken advantage of and the market seems to enjoy their position in corporate credit.

We want to be the guy in real estate credit, so we are working to make sure that our engines are going and we're fine-tuning our team, and hope to come out of this, what I call, it's kind of like the cars on the. What do they call it when the cars are going around the racetrack? The white flag is out, and you're trying to figure out, like, when it's safe to get back on the track and drive full speed. I do think we're very well positioned for full speed. A lot of our business lines are kind of asleep. The conduit business only did two securitizations. There just aren't a lot of transactions to do.

We have a bunch of REO that's not producing any cash, but there's significant value there as the markets recover, including our largest loans in those books, as we can redeploy that capital, which is not in our earnings, that will be accretive to the company. Jeff mentioned how accretive or not dilutive it is for us to build up cash and pay off lines, earning only 8% on our cash because we're paying off lines. And it is true today that the only lender for many of these assets is the existing lender. So a lot of borrowers are just working with their existing lenders, which limits the opportunity set for new capital to come in and deploy capital at these extremely favorable spreads and rates.

I think the first thing, people talk about the reduction of rates, and we'll all follow what happens, and I think the forward curve is good. I mean, it's favorable, and rates should come down, but I would guess that the curve is wrong, and rates will come down further because I don't think you'll have a 300 basis point real interest rate 'cause the economy can't stand it, and neither can the global markets. The market's too fragile. There's no real engine of growth worldwide right now, pulling the global economy up other than maybe defense spending, which is a sad comment. So I think when you see rates that are peaked, you'll see spreads come in, and that will be a double whammy. So rates will come down.

It's sort of an unnatural world for AAAs to be 250 over or 240 over. In some asset classes, they're 180, but they used to be 80. So you should see once fear dissipates and we're on the backside of this, you'll see both base rates come down and spreads come down, which means you really want to be a lender today, if you can. And hopefully, we'll be in a position to go more on offense next year. But we are being careful 'cause it is a minefield out there. There are a lot of situations today out in the marketplace where you can see there could be trouble, and we just want to be careful.

We're here for stability and to rid the consistency of our distributions and transparency, which we've gone from the start of this company 13 years ago. I'm really excited to finally get into Starwood Solutions business. Long ago, a small firm named BlackRock created a credit software package to help them manage their book and exposures. That became BlackRock Solutions, and they built that into, last I looked, about a $500 million EBITDA business. Now, we do many things that banks do but don't do that well, and other people, which is workouts. And LNR, being the one or second largest special servicer in the nation, has a large, dedicated team with huge experience, backed by a massive database, a technology-powered database, that helps it maximize value of real estate assets.

So we are going to expand that business, dedicate resources to it. It's incredibly high ROE, obviously, ROI. There's no invested capital. It's just fee streams off of the intellectual capital of our business. And I would hope that become, over time, a meaningful new business line for the firm. And last, I mean, I want to talk quickly about the question I get every time I speak about anything today is U.S. office. U.S. office is clearly bifurcated. New ESG-compliant great buildings are full and holding their rents, and everything else is struggle. There is leasing volume. It's not like there's none in the United States, so the net. There's no net new absorption. But in general, these real estate markets are not an issue. There's some overbuilding of multis and downtowns in certain markets. That will pass.

Obviously, the good news for multis and the construction is people can't buy homes. They're either not being built, or they can't afford them. We have 50-year lows in homes. So even though apartment rents are slowing, I would expect they would re-accelerate over the coming 24 months, supporting that asset class and everything in the residential asset class. So hotels continue to hold their own, shockingly, and now they're full with their employees. They've hired everyone back that they didn't have, so margins are normalized. I would expect leisure travel to weaken. It already is in the United States, not so much so in Europe yet, but we have a good margin of safety, and we've had some of our hotel loans paid off. And one other comment, and then I'll stop, which is future funding.

One of the things that sort of worries me is when we don't have the liquidity we want for loans repaying, but we have commitments on future funding, and it's among the lowest it's ever been in our firm's history. So I think we've set up ourselves to succeed going forward, and the team is locked in and doing a job. And I'm thanking the board again for their gracious support and advice as we navigate these choppy waters. So with that, I hope I'm going to stop and thank everyone for listening, and we'll take questions.

Operator (participant)

Thank you. If you'd like to ask a question at this time, please press star one from your telephone keypad, and a confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please, while we poll for questions. Thank you. Our first question is from the line of Stephen Laws with Raymond James. Please proceed with your questions.

Stephen Laws (Managing Director and Equity Research Analyst)

Hi, good morning. First off, Barry, hope you feel better soon. I hate to hear about the under the weather. To follow up on your last comment, you know, can you touch base on office? I thought follow up more detail on office. Thought it was notable, no exposure now to Manhattan office and no exposure at all to San Francisco. Are there certain marquee assets or Class A assets that you would look to do loans with in office, or you feel other opportunities better to put capital to work? And sort of along that front, you know, how is office potentially going to be disrupted, you know, around the WeWork filing for bankruptcy?

Jeff DiModica (President)

Barry, you want me to start and hand it to you? Go.

Well, I'll, I'll do WeWork, then you do the rest of it. You know, WeWork had a profitable business underneath the business. They just had too many sites, and they needed to I mean, they were they got hit with a one-two punch, right? They were recovering nicely, gaining enormous market share of new lease space, and then the pandemic hit.

And, that kind of really hurt them. And they didn't have they never had the right capital structure, and SoftBank was very reluctant to support the company. And increasing the cost of debt and then the interest rates rose, of course, they were the only lender to save the company, and they kind of, Masa just kind of wanted to wash his hands of the thing. But there is a real viable business. The shared office space business is a real business, and WeWork has a global brand. So my guess is they will reorganize, and they will come out as a profitable entity, much smaller than they went in. They're just getting rid of unprofitable leases. So the impact on the office markets like New York will not be good.

I think I've read they're giving back 30 or 40 spots, but, WeWork will, I guess, survive. Certainly, without debt, they can run a profitable company, and they'll have to figure out the right overhead levels for a company that's not in hypergrowth, 'cause even though they cut them hard, they probably have to cut them even harder. So that's WeWork. And on office, Jeff, you want to give your thoughts, and then I'll see if I have any different thoughts on, obviously, not next to you, so.

Absolutely. Let me touch on WeWork a little bit more for a second. You know, we don't know which leases will be given back yet of the 20 million sq ft. There are articles that say that it won't affect leases outside the U.S., Obviously, we're not sure how that plays out. We do have four assets that have exposure. WeWork represents 1.2% of our total office square footage, and less than 1% if you exclude a Dublin lease that's 100% occupied by TikTok. That number becomes less than 0.5% if you take out a Southern California asset, where we have a $4 million letter of credit that covers rent through expiration.

Of that 0.5%, more than half of that is a Berlin asset that they brought current just this week. So them bringing it current just this week tells us they likely plan to stay, leaving us one asset in D.C., where 9% of the building is WeWork. So we feel really good about what our exposure looks like here. We never really leaned in on lending to WeWork occupied buildings, so we feel pretty good about that. As far as office, you know, you guys know there's been a massive bifurcation between Class A and Class B. The best buildings are leasing. They're leasing at incredible rents, and the weaker buildings are not going to see that kind of rental growth going forward.

So we will look at high-quality Class A office buildings. We will not look at Class B lease-up. You know, I mentioned we got out of two Class B office buildings. That won't be the case for a lot of Midtown Manhattan Class B office buildings. With the tenant improvements and leasing commissions and money you have to put in on these assets, the net effect of rents after free rent just do not cover you in a lot of different scenarios, and a lot are not able to be converted. So Barry, I'd hand it to you if you have anything different to say on the office side.

Barry Sternlicht (Chairman and CEO)

Well, the office market reminds me of the retail market when malls were all going bankrupt, and obviously, they didn't all go bankrupt, and Sean recently reported with real same-store sales growth. So the capital markets dry up for an asset class, and obviously, office is a, is a four-letter word, much like a mall or retail was a couple of years ago. So it is an unbelievable opportunity set. Loans on office buildings today are 9%, 10%, 11%, and that's one of the problems. If you're borrowing at 9%, 10%, 11%, what's the cap rate on the office, even a good one? So if you have a trophy building and it's well leased, it's really about the stability of the cash flow stream, the rollover schedule.

You probably wouldn't want to do anything that was full today and had an opportunity to roll over the next two years. But I think we, we would look favorably with low leverage on some, you know, trophy office buildings in major markets that had great credit profiles, because we're going to get the, probably the best returns of any loan we could make. And we'll just use our equity real estate underwriting skills to, to make sure we feel comfortable about that real estate in that market. And, you know, we It's interesting what you see in our book.

I mean, we've had sort of great assets with, I'd say, not overly well-capitalized borrowers, then we have great assets with great borrowers, household names, the largest we're the, I think, the third-largest real estate player in the opportunity set that we compete in. And all of us are giving back buildings. And why are we doing that to lenders? And we're doing that because if you're in San Francisco, which we're not, you have a 30%+ vacancy rate. You don't know what the lease rent is going to be when you actually lease, but you also don't know what the TI package is. And if you're the borrower, now you're looking at a building and saying, "I got to put another $50 million. I have $50 million in.

I got to put $50 million to retenant it, and maybe I have to pay down the existing loan." And you're just really nervous about the. And then you look at the exit cap you need in order to justify putting that capital in and get a return on it, and that equation is still murky. So, you know, again, as rates fall, will six and seven and eight return, even five, to best office buildings in the United States? My guess is they will, at some point. In Europe, you're already there. You know, in Europe, where rates are lower, in Germany, where the 10-year is 2.80%, the office markets are fairly full, and rents are actually rising.

So, but even there, where there are some great markets, office is still, in the investing world, a four-letter word, or it's like not a four-letter word, but it's close to it. And so I think at the moment, all the press, it will have to play out. You'll have to see it play out, but I think there'll be really good opportunities for smart investors to pick off very good leverage returns in the space, going. We wouldn't put a red circle around it, if that was the question. We won't, we won't not lend to office. When everybody runs away, that's, I think it was David Bonderman who said, when there are tanks rolling down the streets, is when he wants to invest.

I'm not sure we're the tank down the street, but for office, we probably are. And, we're not. You know, we'll have to explain every office loan we make to you. So, you know, we, we'll have to have a very thin sieve in order to make those, in order to make an office loan. But no, I wouldn't say never. I'd say, at the moment, it's not really our, our top choice of things to invest in, but not never.

Stephen Laws (Managing Director and Equity Research Analyst)

Great. Yeah, there'd be no further questions on that. Appreciate the comments this morning.

Barry Sternlicht (Chairman and CEO)

Sure. Thank you.

Operator (participant)

Our next question comes from the line of Sarah Barcomb with BTIG. Please proceed with your questions.

Sarah Barcomb (Equity Research Analyst)

Hey, everyone. Thanks for taking the question. Maybe to just pivot from office to multifamily for a second. On last quarter's call, you spoke to a sort of break-even cap rate on the multifamily book of about 6.5%, and a willingness to take over those assets at, say, $0.65 on the dollar, where sponsors walk away. I was curious if you could provide some updated thoughts there, just given, you know, the forward curve has come up since then, and we've heard Powell reiterate that he's not thinking about rate cuts yet. Also just curious where the debt yields are looking on for those assets. Thank you.

Jeff DiModica (President)

Barry, do you want to start?

Barry Sternlicht (Chairman and CEO)

Yeah, I mean, there's probably no. It's interesting, as you think about 30 years of doing this, capital flows sometimes are overwhelmed fundamentals. And, the rent growth is slowing, and in some markets like Austin, they're negative. For apartments, the asset class is definitely going to be a favorite for institutional investors going forward. You can't take a $3 trillion office class, asset class like office, shut it off from investment, and real estate capital is going to have to go somewhere. And, hotels are kind of verboten for a lot of institutions. So, retail, maybe, I mean, nobody's rushing to do tons of retail deals today, even though the markets are relatively healthy.

Industrial, possibly, it's a bond, and the economy will slow, so rents will come down and the pace of rent increases are coming down also in industrial. So I think multis benefit, and that was why the comment was, we'd be happy to take assets back. And we are taking one back and selling it immediately, it looks like, to someone in Portland on one of our troubled multis. But I think, in general, what we said before is true. We will make more money, in my view, if we can take these assets back, than we will just staying as a lender, though we will stay as a lender. That's our primary job.

So, if we're in fact at 65% of value or 65% of construction costs or 65% of the renovation, totally renovation costs, you know, we. It's city by city, but I look at that as sort of an opportunity and, and not a, not a bad thing. They are. They're not going to be empty. You know, when we took back an office building in D.C., it's interesting building. We, we have it on our books. It was bought by a household name. They emptied the building, re-skinned the building, and then realized that with, they were that the amount of capital they'd have to put in to re-tenant the building justified them walking away from $100 million of equity. That deal is empty, so that's a drag.

Any multis we get back are partially full and probably yielding 5.75% to 6%. So not, not terrible. And if we like the assets, which hopefully we do, we lent against them, this should be good opportunities for us going forward.

Jeff DiModica (President)

Yeah, Barry, I don't have much to add. You know, I did make those comments about our break-even cap rate being around 6.5%. As I look at our portfolio, our in-place debt yields are mid-60s today, and we expect they'll stabilize significantly higher than that. But obviously, as Sarah, as you mentioned, the forward curve has gone up. So a lot of this is going to depend on what does the forward curve look like a year out, in a year? If people are faced with a refinance, will they make the decision to hold on or not? And I think that decision to hold on will be mostly about liquidity. I think that people will think that they're going to have an opportunity at a lower cap rate in the future to be able to sell it.

And will they be able to hold on? Will they have the cash flow available to buy a cap and wait it out? We obviously do. We will support the assets. As Barry said, they have debt yields that almost, that would almost cover today, even on the lowest debt yield assets. It would not cost us a lot to stay in those assets and with the right to own them at 65% of cost, and wait for a better environment to either refinance them or to sell them. I think that's something, that's not a task that would be a great investment for us, and we would do that in defense.

Sarah Barcomb (Equity Research Analyst)

Thanks for the comments.

Operator (participant)

Our next question comes from the line of Don Fandetti with Wells Fargo. Please proceed with your questions. Mr. Fandetti, your line is live for a question. Perhaps you're muted.

Don Fandetti (Managing Director and Senior Equity Research Analyst)

Yes, Jeff, should we expect continued growth in infrastructure lending relative to CRE? And also, can you talk about the competitive dynamic in infrastructure and how those assets would perform if we did go into a recession?

Jeff DiModica (President)

Sean, do you want to call it?

Sean Murdock (President of Starwood Infrastructure Finance)

Absolutely, Don. Thank you.

Jeff DiModica (President)

Yeah, Sean, Sean is sitting next to me. You know, we do expect to have continued growth here. We think it's tremendously attractive. As I was saying before, where I started was to say that our asset spreads, what we're earning, have gone up commensurate with what our asset spreads have gone up in other asset classes like CRE lending. The liability side hasn't increased by as much. The banks aren't retrenching the way that they're retrenching in CRE, so we're able to earn sort of the highest yields that we've had in a while. A couple of other tailwinds, excuse me. Global power demand is going up massively, and you know, it could double or triple in the next 15 years, are the estimates that you see.

So the power plants that we have that start off with a low loan-to-value generally deleverage over the life of the loan. They're going to be worth more, not less. I think the transition to a more ESG solar, wind, et cetera, world is going to take a lot longer. Last quarter, I talked about the fact that even if it doubles every year, it still will get to low 20s% of total energy demand in the next 10 or 12 years. So the rest has to be done somewhere. The traditional markets are not there in depth to finance these power plant assets in midstream storage and transmission assets. You know, we believe that this transition is going to take a lot longer.

It's going to be a great opportunity, and the structural nature of these assets, where we get significant amount of deleveraging over the life and end up at a dollar per kilowatt, that feels really cheap on the roll, makes this a super attractive asset class for us. Sean Murdock is sitting next to me. Sean, anything to add to that?

Sean Murdock (President of Starwood Infrastructure Finance)

Not really, Jeff. The only thing I'd add is just that, you know, I agree with Jeff's view of the energy transition. It's going to take longer. Banks have decided with their lending strategies that it's going to come sooner, if it hasn't already come. So I think that's where we get the tailwinds in this sort of market for putting new loans out. Most banks have decided the transition has happened, and they've reduced their lending to traditional energy assets.

Thank you.

Jeff DiModica (President)

Thanks, Don.

Barry Sternlicht (Chairman and CEO)

Just, I want to go backwards just on one thing. I talk about multis. The key is that the wave of construction will be over next year, and construction starts for multis have dropped to 250 from 600,000 or so. So, that should bode really well for rental growth going forward. So we. You know, real estate's a long-term game. Also, construction is in the downtowns. It's not in the suburbs so much, so, it's pretty concentrated. You can. You understand, a lot of these deals were built for a different rate environment, so there'll be a lot of opportunity, I think, to take advantage of that if you're a long-term player, and you have the capital to do so. I think we have both.

And then on infrastructure, yeah, I mean, you know, infrastructure's been our highest returning asset class. So, yes, we will continue to 90% of our book, as mentioned, is post-acquisition of the GE business. So, the team's intact and finding great stuff to do, and a lot of our investments are in behind that platform right now. Safer, safer, safer, safer place to be.

Thanks, Don.

Operator (participant)

The next question

Zach Tanenbaum (Director of Investor Relations)

Next question, operator.

Operator (participant)

Yes. The next question is from the line of Jade Rahmani with KBW.

Jade Rahmani (Managing Director of Equity Research Analyst)

Thank you very much. Good to hear the comments around Starwood Solutions. I was worrying that Starwood might miss this, miss this moment. For the banks, we estimate their CECL reserves and NPL ratios are 1.5% to 2.5%, which on their balances of CRE loans is massive and are still increasing, up 25 to 90 basis points per quarter. Do you see working with the banks, the special service assets, as the biggest opportunity in front of, this Starwood Solutions initiative?

Jeff DiModica (President)

Yeah, Jade, we would love to have the banks come to us. You know, we're super fortunate to have this LNR business. As I mentioned on the prepared remarks, we have over 200 people who have done this for over 30 years and worked out $88 billion of assets. You know, it could be the banks. Hopefully, the FDIC is listening, and they give us a call. There are certainly lots of property owners, pensions, insurance, other investors, large players who could use our help. The broker network that we use every day at Starwood Capital and have relationships with all the biggest brokers, you know, they get asked to do reviews and portfolio evaluations every day. They are not experts at working out assets.

They are experts at buying and selling and financing assets, and we want to go to them and have them bring us the opportunities that they're seeing to both evaluate and help in workouts. You know, this is what we do, dealing with workouts between bespoke interactions between banks and clients or securitizations. We have experience in doing it all, and you're one of the people who pushed us over the last few years, so we appreciate that. We've now hired a team and we think it's an extremely exciting opportunity, and hope that people listening who are wondering about their portfolio evaluations or asset valuations or what to do in a difficult time want to come to a shop that has done this $88 billion times over the last 30 years.

So we think we have a lot of expertise to offer here, and we're really hopeful that we can grow this into something. You are right, the time is now.

Barry Sternlicht (Chairman and CEO)

Just a quick. Not everyone in our group has been with us 30 years. Just to be clear. The head of the group.

Jeff DiModica (President)

The group's been together for 30 years.

Barry Sternlicht (Chairman and CEO)

Yes, we've been doing this 30 years. But, and the guy who runs it has been with us actually 31 or 32 years. You know, it is much like Guggenheim serves as the front end, and for small insurance companies, we should be the back end for many regional banks and, and maybe some of the larger players like the FDIC, but we, we, we do have an incredible ability to do this. I think they'll work in tandem, Jade. I think the increase in the name or the actual book, I think we have $101 billion or $102 billion in servicing, named servicer. That number is what's actually being REO or serviced by us, I think, is $7 billion or $8 billion today, or six to eight, something like that. That number should go back up.

I mean, you can see we're going to get a lot of business. It won't be as profitable as it was before because the CMBS securities, the loan documents have changed. But it'll still be profitable. This could be bigger than that. So we'll get to work and give it a shot.

Jade Rahmani (Managing Director of Equity Research Analyst)

Do you see, as a follow-up, M&A as an interesting deployment opportunity within this segment? You know, there's many financials in the non-bank space that are under duress due to their capital structure, and there could be fee income services businesses within that. You know, we've seen others in, my coverage, such as Newmark, grow in their servicing, sector, and there's also some private brokers in the broker directory that are facing stress.

Barry Sternlicht (Chairman and CEO)

Send us their names.

Jeff DiModica (President)

Yeah. Yep. And anyone listening, please call us. You know, we've had a difficult time.

Barry Sternlicht (Chairman and CEO)

A good Jade. The answer is sure.

Jeff DiModica (President)

You know, with the premium book value to our peers, obviously, it's accretive if we are able to consolidate the industry. We would love to consolidate the industry. We think we're well positioned to consolidate the industry. Boards of directors who own a book value that they believe in more strongly than the market believes in, or have been unwilling to date us. But we would love to go on a lot of dates if you have anyone listening to this call that would like to become part of Starwood.

Operator (participant)

Thank you. At this time, we've reached the end of the question and answer session. I'll hand the floor back to Mr. Sternlicht for closing remarks.

Barry Sternlicht (Chairman and CEO)

Thank you, everyone, for being with us, and good luck navigating these choppy waters. So hopefully, Powell will take a vacation, and the markets will get a bid. Thanks for being with us today, and hope none of you get COVID. Take care.

Operator (participant)

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.