Starwood Property Trust, Inc. Q3 FY2023 Earnings Call

Greetings. Welcome to Starwood Property Trust's Third Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. 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.

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 30, 2023, filed its Form 10-Q with the Securities and Exchange Commission, and posted its earnings supplement to its website. These documents are available on 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'm now going to turn the call over to Rina.

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 hedged 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 reserves. 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 US 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 nonaccrual 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 held to maturity 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 prepaid 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 received 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 rent level discussed last quarter. A change in HUD max rent calculation this year, resulted in 3.8% of rent growth being deferred to 2024. This portfolio is 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 fourth quarter 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 $0.03 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 CE 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 un-depreciated 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.

Thanks Rina. We've maintained very low leverage at 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 12 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 delever our balance sheet with excess cash by paying these lines down, reducing our interest expense by an average of 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 sheet 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 throughput for plus 275 basis points or higher. And 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 SIP 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 five in anticipation of our taking control for 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 OpEx exposure in half over the last few years with loans on US 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 our fixed rate loans not affected by rate increases, and another 6% of interest reserves or guarantees. So we have interest rate protection on 91% of our CRE loans today. Since COVID, we 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 nonconstruction 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 rising rate, with gains in our rate hedges and in the value of securities held from previous securitizations which have outperformed as prepaid fees 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 duration, 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 valuations, 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-plus 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.

Thank you, Jeffrey and Zach, and good morning everyone. Thanks for joining us. If I sound a bit under the weather, it's because I'm home with COVID, so I might not be as upbeat as usual. I have a few brief comments on the real estate markets. As many of you know, I've been critical of the Fed for a variety of reasons, primarily because the economy was slowing independently and the COVID stimulus was being spent, leading to a situation where there was no longer too much money chasing too few goods. Now, we have less money and fully stocked shelves, as evidenced by retail sales. What I underestimated in my forecast was the extent of the spending dynamics from the infrastructure bill, which has kept construction jobs stable even with rates rising by 500 basis points. The delays in the travel sector, which supported the economy while other sectors weakened, along with the CHIPS Act and the Inflation Reduction Act, and the leftover funds from the American Recovery Act, have collectively strengthened the public economy while the private sector began to recover. I firmly believe that inflation is on the decline. I've been stating this for months on air, noting that roughly one-third of inflation comes from rents, which are decreasing, particularly in the apartment segment. Rents, while still positive, are not increasing at the 10% to 20% rates we saw when the Fed missed the mark; they are now up by 3% to 4%. The Fed's current figures, almost 7% for rents, are declining to around 3%. Inflation might drop below 2%, barring any unexpected changes in oil prices. We are all puzzled by oil prices around $80, especially with the situation in the Middle East, raising concerns about potential disruptions to oil supply and its effect on inflation. I believe we've seen the peak in rates. It seems that Powell and his team are finally recognizing delays in their own data, which they now acknowledge. The challenges within regional banking and the tightening of credit from major banks will have a substantial, albeit delayed, effect on the economy. Therefore, I think we've reached the top of interest rates. Last week, we witnessed a swift 40 basis point increase in the 10-year yield, which supports the real estate sector. Real estate is facing unintended consequences from efforts to combat inflation, with the Fed's actions affecting critical industries like real estate, which generates significant capital gains that contribute to government revenue and help offset rising interest expenses from our $33 trillion debt. The government cannot sustain rolling over nearly one-third of our debt, amounting to almost $10 trillion, in the coming year. We're looking at a looming $500 billion interest bill shortly. Current interest expenses in the budget are remarkably low but will escalate to nearly $1 trillion if changes aren't made. It's worth noting the absurdity of comparing the current situation to Volcker's time when he dealt with a much smaller deficit. This context is crucial for understanding our operations and future prospects. Regarding the budget, the biggest change in February and March this year was the increase in the deficit from $1.3 trillion to $2 trillion due to a decline in receipts, resulting in a $170 billion shortfall. This is shocking because if my team were off by 40% on a number, I doubt they would keep their jobs. The government is not fully recognizing how their actions affect the revenue side of the deficit equation. The sale of assets contributed to a $91 billion variance from the initial deficit forecast, while a $171 billion miss in receipts, along with $100 billion low interest expenses, reveals forecasting inaccuracies. As a result, there's been a significant decrease in corporate mergers and acquisitions, with real estate transactions down by 60% to 65%, limiting our opportunities to invest capital in other players in the market. Interestingly, regional banks, which hold $1.2 trillion in real estate debt, alongside money center banks, are under significant pressure from regulators to cut exposure to real estate. This situation has created what may be one of the best lending environments we’ve seen since we established this firm in 2009 during the global financial crisis. There are exceptional opportunities for private credit, and we aim to position Starwood as a leading private lender in this sector, much like other alternative managers have in corporate credit. We are ensuring our processes are fine-tuned and are prepared to accelerate when the time is right. While there remain some challenges, including limited transactions in our conduit business and various real estate-owned (REO) assets not generating cash but holding significant value, we expect to redeploy capital positively as markets recover. Feedback on our cash accumulation and paying down lines of credit shows that many assets currently only have their existing lenders as sources of financing, which constrains new capital from entering the market at favorable spreads and rates. The prospect of reducing rates appears promising, but we anticipate that rates will decrease further; the economy cannot tolerate a 300 basis point real interest rate given its fragility. Considering the lack of true growth drivers globally, apart from perhaps defense spending, we can expect spreads to tighten as rates fall. It seems unnatural for AAAs to be trading at such wide spreads compared to historical levels, indicating that once the current volatility subsides, lenders should be positioned favorably. We are carefully navigating this complex environment, prioritizing stability and consistent distributions, which has been our commitment since we founded this firm 13 years ago. I am also excited about our expansion into the Starwood Solutions business. A small firm named BlackRock launched a credit software package to manage its assets that evolved into a substantial business. We offer similar services, focusing on workouts and servicing, particularly through L&R, which is among the largest special servicers nationally, backed by powerful technology that enhances the value of real estate assets. We aim to dedicate resources to grow this high-return business line. Lastly, I want to briefly address the topic that consistently arises—US office space. The market is clearly divided; top-tier, ESG-compliant buildings are fully occupied and maintaining their rents, while other properties are struggling. Leasing activity does exist in the US market, but with no net new absorption. However, I do not view real estate markets as a significant concern overall, despite some overbuilding in multifamily and urban areas which will correct itself. A silver lining for multifamily and construction is that prospective homebuyers face challenges in purchasing homes, as they are not being built and affordability is a concern, with 50-year loans becoming more common. Consequently, while apartment rents are slowing, I believe they will rebound in the next 24 months, providing support for that asset class as well as the broader residential sector. Hotels, remarkably, are performing well and have successfully rehired their staff, normalizing margins. I expect leisure travel to pick up in the US, though it hasn't fully happened in Europe yet, but we have a strong margin of safety. Some of our hotel loans have been repaid, which is positive. One final point of concern is our current liquidity for repaying commitments; it's the lowest we've seen in our history. This positioning, however, sets us up for success moving forward. Our team is focused, and I want to express my gratitude to the Board for their support and guidance during these turbulent times. Thank you all for listening, and I look forward to your questions.

Thank you. Our first question is from Stephen Laws with Raymond James. Please go ahead with your question.

Hi. Good morning. First off Barry, I hope you feel better soon. I hate to hear about the—under the weather. To follow up on your last comment, can you touch base on office? I thought a follow-up more detail on office. I 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 do you feel other opportunities are better to put capital to work? And sort of along that front how is office potentially going to be disrupted around the WeWork filing for bankruptcy?

Barry, I will hand it over to you.

I'll do WeWork, then do the rest of it. WeWork had a profitable business underneath the business. They just have too many sites and they need to—I mean they were hit with a one-two punch, right? The 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 interest rates rise, of course, they were the only lender to save the company and they kind of, not just kind of wanted to wash their hands of the thing. But there is a real viable business—a shared office space business is a real business and WeWork is 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, well, I guess, will survive certainly without debt; they can be a profitable company and they'll have to figure out the right overhead levels for a company that's not in hypergrowth because even though they cut them hard, they probably have to cut them even harder. So that's WeWork. And on office, Jeff do you want to give your thoughts and then I'll see if I have any different thoughts obviously not next year.

Absolutely. Let me touch on WeWork a little bit more for a second. We don't know which leases will be given back yet of the 20 million square feet. There are articles that say that it won't affect leases outside the US; 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 exploration. And 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 guys know there has 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, Class B lease up. As 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'll hand it to you if you have anything different to say on the office side.

Well, the office market reminds you of the retail market when malls were all going bankrupt. Obviously, they didn't all go bankrupt and Simon recently reported real same-store sales growth. So the capital markets dry up for an asset class. And obviously office 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 problematic 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 and the rollover schedule. You probably would want to do anything that was full today and had an opportunity to roll with low leverage on some trophy office buildings in major markets that had great credit profiles because we're going to get probably the best returns of any loan we can make. And we'll just use our equity real estate underwriting skills to make sure we feel comfortable about that real estate in that market. And 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—they're the—I think the third largest real estate player in the opportunity set that we compete in. And all of us are getting back buildings. And why are we doing that to lenders? We're doing that because if you're in San Francisco which we're not, you have a 30% vacancy rate. And then 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 the building and saying; I got to put another $50 million. I have $50 million and they got to put $50 million to retenant debt and may they have to pay down the existing loan and you're just really nervous when you look at the exit cap you need in order to justify putting that capital and getting a return on it. And that equation is still murky. So again as rates fall, will 6s and 7s and 8s return even five to best office building in the United States? My guess is they will at some point. In Europe, you're already there. In Europe, we're where rates are lower—in Germany, with tens to 80, the office markets are fairly full and rents are actually rising. So—but even there where there are some great markets, offices are still in the investing world a four-letter word, or if it's like not a four-letter word, but it's close to it. And so I think at the moment all the press and it will have to play out. You'll have to see it play out. I think there will 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, not lend to office. And when everybody runs away, that's—I think it was David Bonderman has said when there are tanks rolling down the street 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—we'll have to explain every office loan we make to you. So we'll have to in order to take an office loan. But I wouldn't say never. I'd say at the moment it's not really our top choice of things to invest in, but not never.

Great. Yes, there'll be no surge of questions on that. I appreciate the comments this morning.

Thanks, Stephen.

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

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 breakeven 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 the forward curve has come up since then 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.

Barry, do you want to start?

Yes. 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 an investment, and the real estate capital is going to have to go somewhere. And hotels are kind of bought for voting for a lot of institutions. So retail, maybe—nobody is rushing to do tons of retail deals today, even though the markets are relatively healthy. Industrial possibly it's a bond and the economy was slow. So rents will come down and the pace of rent increases are coming down, also in industrial. So I think multi-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 someone in Portland on one of our troubled multis. 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 and we will just stay 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 total renovation cost city-by-city, I look at that as sort of an opportunity and not a bad thing. They are—they're not going to be empty. We took back an office building in D.C. It's an interesting building. We have it on our books. It was bought by a household name. They emptied the building, reskin the building and then realizing that the amount of capital they have to put into retenant 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% or 6%. So 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.

Yes Barry, I don't have much to add. I did make those comments about our breakeven cap rate being around 6.5%. As I look at our portfolio, our in-place debt yields are mid-6s today and we expect they'll stabilize significantly higher than that. But obviously, as Sarah, as you mentioned, the forward curve it's 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 the 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 would almost cover today even on the lowest debt yield assets, it would not cost us a lot to stay in those assets and for 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 would be a great investment for us and we would do that in defense.

Thanks for the comment.

Our next questions come from the line of Don Fandetti with Wells Fargo. Please proceed with your question. Mr. Fandetti, your line is live for question, perhaps you're mute.

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?

Sean's sitting next to me. 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 headwinds—tailwinds excuse me, global power demand is going up massively and it could double or triple in the next 15 years or 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 more ESG, solar, wind, royalties is going to take a lot longer than last quarter I talked about the fact that even if it doubles every year it still will get to low 20% 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 the power plant assets in midstream storage and transmission assets. 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 ends up at $1 per kilowatt is really cheap on the role makes this a super-attractive asset class for us. Sean Murdock is sitting to me. Sean, anything to add to that?

Not really Jeff. The only thing I'd add is just, the Jeff's view of the energy transition—it's going to take longer. Banks have decided with their lending strategies that'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 is happened and they've reduced their lending to traditional energy assets.

Thank you, guys.

Thanks. Just I want to go backwards just on one thing. I talk about multi—the key is that the wave of construction will be over next year and construction starts from multis have dropped to 250 from $600,000 or so. So that should bode really well for rental growth going forward. So we—real estate is a long-term game. Also, construction is in the downtown. It's not in the cyber so much. So it's pretty concentrated. You understand a lot of these deals were built for a different rate environment. So there will 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, yes, I mean infrastructure has been our highest returning asset class. So yes, we will continue—90% of our book mentioned is post-acquisition of the GE business. So the team is intact and finding great stuff to do, and a lot of our investments are behind that platform right now. Safer—a safer place to be.

Thanks, Don. Next question, operator?

Next question is from the line of Jade Rahmani with KBW.

Thank you very much. Good to hear the comments around Starwood Solutions. I was worrying that Star might miss this moment. So the banks we estimate their season reserves and NPL ratios are 1.5% to 2.5%. And 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 to special service assets as the biggest opportunity in front of the Starwood Solutions initiative?

Yes, Jade. We would love to have the banks come to us. We're super fortunate to have this L&R 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. 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, and 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. They get asked to do reviews and portfolio valuations 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 work out. We—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 valuations 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.

Just a quick—not everyone in our group has been at 30 years. The head of the group is 30 years.

But the group, all together, is 30 years.

Yeah. And we've been doing this 30 years. But—and the guy who runs it with us is actually 31 or 32 years. It is much like Guggenheim surge as the front-end and for small insurance companies we should be the back-end for many regional banks and maybe some of the larger players like the FDIC, but 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 that we have $101 billion or $102 billion in servicing—the named servicer, that number is what's actually being REO or serviced by us, I think it's seven or eight 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. They'll still be profitable. This could be bigger and could that. So we'll get to work and get the shot.

And do you see as a follow-up M&A as an interesting deployment opportunity within this segment? 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. We've seen others in my coverage such as Newmark grow in the servicing sector. And there’s also the private broker and maybe brokers cover the rigs that are faced in track.

Send us their names.

Anyone listening please call us. We got a difficult time. 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.

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

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

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