Sternlicht: Largest US cities are playing ‘a dangerous game’

Barry Sternlicht, chairman of Starwood Capital, is bearish on America’s biggest cities.

During the first-quarter earnings call for his firm’s listed mortgage REIT, Starwood Property Trust, Sternlicht said Democratic regimes in New York and elsewhere have squeezed landlords through high taxes on the one hand and rent controls on the other. “That’s a dangerous game to play, and that is a very difficult real estate environment,” Sternlicht said.

Meanwhile, from the firm’s headquarters in Miami Beach, Sternlicht has seen how the Republican-led state’s low-tax, business-friendly policies have helped it thrive during the pandemic. At Starwood’s newly built headquarters, for example, rents to third-party tenants are 25 percent higher than what the firm underwrote, he said, highlighting the rising appeal of the market.

Until states like New York and California change their taxation strategies, Sternlicht said, their real estate appeal will be limited. “You need a tsunami of change of attitude in these dark blue states,” he said. “And it’s a travesty. They have so much going for them, so much culture, museums, art, sports teams and wealth. But the attitude is not conducive for excess gains in real estate.”

Buying the flex model

Along with low-cost Southern cities, Sternlicht also is optimistic about the potential for flexible office space coming out of the pandemic.

Starwood Capital was part of the group of investors that committed $800 million to the SPAC acquisition of WeWork in late March. Its commitment was part of a $1.3 billion transaction led by the BowX Acquisition Corp, a blank-check company sponsored by venture capital firm Bow Capital. As a result, the once-mighty co-working giant will bypass the initial public offering process to finally be traded on a listed exchange.

During this week’s earnings call, Sternlicht said the short-term lease model makes sense for small businesses and has already proven profitable outside the US. “Somebody is going to make money in short-term co-working, because, if you’re a small tenant, why would you ever lease a space for 10 years?” he said. “Our bet is that people come back and it’s for a more flexible approach, and that becomes a real business in the US, as it has already become in the UK and other places.”

Hospitality heat check

While Sternlicht sees reasons for excitement in the hotel sector, with ample pent-up demand for travel coming out of the pandemic, he is still exercising caution. The former chief executive of Starwood Hotels & Resorts sees markets getting “ahead of themselves on hotel stocks.”

Sternlicht agrees that pent-up demand will send travelers flocking to domestic destinations this summer, but he sees that enthusiasm being short-lived and burning off by the end of the summer. Similarly, he expects crowds of shoppers at physical stores as lockdown measures ease, but he does not expect that to turn the tide on e-commerce.

Ultimately, there will be a new normal for demand on both fronts, he said, but what that normal will look like remains to be seen: “We look at these things, even on the equity side, and we kind of scratch our heads and wonder what the trajectory will be.”

Starwood Capital manages $75 billion of real estate assets and is in the process of raising its 12th flagship fund, Starwood Distressed Opportunity Fund XII Global, which is targeting $7.5 billion.