Barry Sternlicht, co-founder, chairman and CEO of $115 billion real estate giant Starwood Capital Group, is concerned about the more than 4,000 regional and community banks in the U.S. The billionaire investor says the real estate industry is struggling with rising interest rates, vacancies and inflation, and preferred lenders could feel the pain.
“I think people are looking for these cracks and now you're going to see those cracks widen. You're going to see community banks fail every day. Every week, maybe even twice a week,” he told CNBC on Tuesday.
Contrary to Sternlicht's prediction, only one U.S. bank has failed so far this year: Republic First Bank, a regional lender that operated in Philadelphia, New York and New Jersey. The bank collapsed and had about $6 billion in assets and $4 billion in deposits seized by the Federal Deposit Insurance Corporation (FDIC) after it faced rising interest rates on its large commercial real estate holdings.
Sternlicht has been warning for more than two years about looming problems from rising interest rates in the real estate and banking sectors and the broader economy. In September 2022, just months after the Fed began raising interest rates to fight inflation, he said officials were unnecessarily bombarding the economy with “stale inflation data,” particularly housing-related data. A month later, Sternlicht followed up on that criticism, arguing that soaring borrowing costs were causing a “sharp deterioration” in the overall economy and making a recession all but inevitable.
But Sternlicht acknowledged that predicting a recession was premature, saying he “didn't understand the strength of the consumer,” as the U.S. has proven resilient to rising interest rates and inflation by the summer of 2023. But the billionaire real estate guru still believes certain sectors of the economy, such as real estate and regional banks, will not be able to withstand Fed Chairman Jerome Powell's rapid rate hikes.
“He's been using a blunt instrument to execute a difficult task, and the result is that interest rates have skyrocketed, hurting the real estate market. We could have dealt with this, but not as quickly as we did,” Sternlicht said. “$1.9 trillion in real estate loans are now vulnerable.”
Calling on the Federal Reserve to Cut Interest Rates Again
While many parts of the real estate sector are struggling (multifamily property values are down 26.9% from their peak in the second quarter of 2022, for example), the office sector is facing more headaches than any other.
The combination of rising interest rates (higher borrowing costs and lower asset values) and the rise of hybrid work (higher vacancy rates) has hit office landlords particularly hard in recent years. In January, Sternlicht even told Bloomberg that the office real estate market is currently in an “existential crisis” and could face losses of $1 trillion. If his prediction proves prescient, it would lead to serious problems for regional and community banks that have real estate debt but don't have large balance sheets to weather excessive loan losses.
Wall Street analysts, strategists and real estate industry leaders have been warning of potential problems for regional banks as real estate loans go bad over the past year. Scott Rechler, CEO of New York-based real estate investment, management and development company RXR, told Fortune in March that regional banks essentially face a “slow-moving train wreck.” As commercial real estate loans come due over the next few years and values in the real estate sector plummet, banks will struggle to keep up with mounting loan losses, Rechler argued.
“We will see over 500 fewer banks in the U.S. over the next two years,” he warned. “I'm not saying all the banks will fail, but those that don't will be forced to consolidate.”
For Sternlicht, at least some of that nightmare could be averted if the Fed decided to cut interest rates. “One of the ways to get capital into these banks is to lower interest rates, which basically makes their asset values go up,” he said.
The billionaire CEO argued that community banks are essential to the “foundation” of the American economy and are worth saving because they lend to small businesses and farms that big banks often ignore. The good news? Sternlicht thinks Powell could cut interest rates sooner or later, saving some of these banks.
Mr. Sternlicht has argued that raising interest rates is no longer having the desired effect of curbing inflation and is instead unnecessarily harming the real estate industry and local banks. And Mr. Powell is beginning to realize that.
Sternlicht noted that most Americans also have mortgages locked in at low interest rates, so “their incomes are not affected by rising interest rates,” and that the Fed's policy doesn't directly affect the prices of gasoline, food, or insurance, some of the key areas causing the current stubborn inflation. In Sternlicht's view, rising interest rates may not be the inflation cure it is meant to be. And finally, with the federal government's budget weighed down by a $34 trillion national debt, Sternlicht argued that Chairman Powell wants to cut interest rates to reduce interest costs. “Interest rates are going to go down,” he concluded. “It seems like Chairman Powell is looking for a reason to cut rates.”
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