Billionaire Barry Sternlicht expects one bank failure per week due to real estate’s ‘fragile’ loans

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Barry Sternlicht, co-founder, chairman, and CEO of the $115 billion real estate giant Starwood Capital Group, is worried about the more than 4,000 regional and community banks in the U.S. With the real estate industry struggling against higher interest rates, vacancies, and inflation, their lenders of choice may be in for some pain, according to the billionaire investor.

“I think people are looking for these cracks and you’re going ‘to see the cracks develop now. You’re going to see a regional bank fail every day, or not—every week, maybe two a week,” he told CNBC Tuesday. 

Despite Sternlicht’s prediction, just 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 roughly $6 billion in assets and $4 billion in deposits seized by the Federal Deposit Insurance Corporation (FDIC) after facing issues with rising interest rates among its sizable commercial real estate holdings.

Sternlicht has warned about pending problems due to rising interest rates in the real estate and banking sectors—as well as the whole economy—for more than two years now. In September 2022, just a few months after the Federal Reserve began raising rates to fight inflation, he said that officials were using “old inflation data,” particularly related to housing, to attack the economy unnecessarily. A month later, Sternlicht followed up that criticism by arguing that the entire economy was “breaking hard” due to soaring borrowing costs, and a recession was all but inevitable.

But with the U.S. proving its resilience to higher interest rates and inflation by the summer of 2023, Sternlicht admitted his recession calls were premature, saying that he “did not understand the strength of the consumer.” However, the billionaire real estate guru still believes certain segments of the economy can’t withstand Fed Chair Jerome Powell’s rapid rate hikes, including real estate and regional banking.

“He’s got a hard task, with a blunt tool, and the consequence is the real estate markets are taking it on the chin because rates rose so fast. We could have handled this, but we couldn’t handle it this fast,” Sternlicht said. “The 1.9 trillion of real estate loans, that’s a fragile animal right now.”

Calling on the Fed to lower rates–again

While many segments of the real estate sector are struggling—for example, multi-family property values are down 26.9% from their second quarter 2022 peak—the office sector has faced more headaches than any other.

The combination of higher interest rates (which raised borrowing costs and reduced asset values) and the rise of hybrid work (which increased vacancy rates) hit the office owners particularly hard over the past few years. In January, Sternlicht even told Bloomberg the office real estate market is experiencing an “existential crisis” at this point, and could face $1 trillion in losses. If his prediction proves prescient, that would lead to serious issues for regional and community banks that hold real estate debt, but don’t have the large balance sheets to navigate excessive loan losses.

Multiple Wall Street analysts, strategists, and real estate industry leaders have warned about potential issues at regional banks due to underwater real estate loans over the past year. Scott Rechler, CEO of the New York-based real estate investor, operator, and developer RXR, told Fortune in March that regional banks are essentially facing a “slow-moving train wreck.” With wave after wave of commercial real estate loans maturing over the next few years, and values in the sector plummeting, banks will struggle to deal with rising loan losses, Rechler argued.

“I think there’s going to be…500 or more fewer banks in the U.S. over the next two years,” he warned. “I’m not saying they’re all going to fail, but they’re going to be forced into consolidation if they don’t fail.”

For Sternlicht, at least some of this nightmare could be avoided if the Fed decides to cut interest rates. “One way to get capital into those banks is to lower rates, so it basically makes their assets worth more,” he said.

The billionaire CEO argued that community banks are worth saving, given they are critical to the “fabric” of the American economy, making loans to small businesses or farms that larger banks often ignore. The good news? Sternlicht believes Powell will cut rates sooner rather than later, potentially saving some of these banks.

Sternlicht argued that interest rate hikes are no longer having the desired effect in reducing inflation, instead inflicting unnecessary damage to real estate and regional banks—and Powell is starting to see that.

He noted that most Americans’ mortgages are also fixed low interest rates “so the rise in rates didn’t change their income,” and Fed policy doesn’t really impact gas, food, or insurance prices directly—some of the key categories causing the current bout of stubborn inflation. In Sternlicht’s view, interest rate hikes might not be providing the anti-inflation medicine they’re supposed to. And finally, with the $34 trillion national debt weighing on the federal government’s budget, Sternlicht argued that Chair Powell will want to lower interest rates to reduce interest costs. “I think that rates will come down,” he concluded. “Powell looks like he’s looking for a reason to bring them down.”

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