Competition to buy high-quality commercial real estate has led to a debt “bubble” in some U.S. property sectors, said Barry Sternlicht, chief executive officer of Starwood Capital Group LLC.
“It’s dangerous,” Sternlicht, also chairman of the Greenwich, Connecticut-based investment company, said today during a panel discussion at the Milken Institute Global Conference in Beverly Hills, California. “You don’t know where rates will be in two years, and that creates a difficult investing challenge.”
Investors have bid up prices for buildings perceived as lower-risk bets in markets such as New York and Washington, reducing yields. Some deals are being completed with the use of financing that doesn’t have fixed interest rates, known as floating-rate debt, Sternlicht said. That’s a “redux” of 2006 and 2007, before the commercial real estate downturn, he said.
Yields on U.S. office buildings fell to 5.9 percent in the first quarter, the lowest since 2007, according to New York-based research firm Real Capital Analytics Inc.
Starwood has been increasingly looking at “off-market” deals that can be completed in as little time as three days, Sternlicht said. Earlier this month, the company agreed to buy seven U.S. shopping malls from Westfield Group for $1 billion. Retail is the “second-best” commercial real estate sector, after apartments, and Starwood is searching for “B-minus” malls to purchase, Sternlicht said.
Excess debt, also known as leverage, is weighing on most U.S. commercial property investors, with the exceptions being companies that own apartments and some large regional mall landlords, such as Simon Property Group Inc., according to Sam Zell, chairman of Chicago-based Equity Residential, the country’s largest publicly traded multifamily owner.
Commercial property owners are stuck with lower rents compared with the market peak, and haven’t been adequately helped by loan workouts known as “extend and pretend” or rising occupancy rates, Zell said during the panel discussion.
“Until the leverage is taken care of, real estate won’t trade, operate and function as it should,” he said.