Jeff DiModica, President of Starwood Property Trust, visited the Baker Program in Real Estate last week as the next key industry leader offering students and faculty insights by way of the Distinguished Speaker Series. During his time at Starwood Property Trust both as President and a director, DiModica has overseen the expansion of the company from its inception in 2009 to its $29 billion in capital deployment since that time, with a market capitalization of more than $5 billion and a portfolio of over $10 billion across the company’s Lending, Investing & Servicing and Property business segments.
Starwood has differentiated itself from other players in the industry due to its scalability and strategy surrounding its timing in entering the market. “In 2009, the lending markets had seized up post crisis, and it was very difficult to get a loan for almost any purpose in commercial real estate, nonetheless commercial real estate that is transitional in nature, said DiModica. “So we focused on writing floating rate loans to transitional properties, properties that have some value add component. It was very difficult to get loans on things that weren’t cash flowing, so we created a vehicle that would give the market some liquidity for non-cash flowing loans.”
As Starwood was the first company to utilize this strategy, it was able to get a higher rate of return and create return that is in the 8.5 to 10 percent a year range. Having Starwood Capital Group as its parent company has also afforded Starwood Property Trust the opportunity to take on loans that most companies simply cannot handle. The average loan size for Starwood is about $100 million and its loan book, which rolls off every two to three years, is about $6.6 billion today. As such, Starwood has to write $4-$5 billion of transitional loans a year and has the employee basis to do so.
In reference to the unprecedented growth of Starwood, DiModica attributes it to the size of its loans and regulation changes that worked in its favor. “One of the biggest reasons we’ve been able to write more loans is regulation changes,” said DiModica. “The banks that we used to compete with for a 70% LTV loan have been forced by Basel III. Any bank that wants to write high touch, high future funding oriented loans is charged 50% more regulatory capital on those loans than they used to be. So they’ve pulled away from competing with us on a 65 or 70% LTV loan and they’ve moved to financing us.” As the banks have shifted into being very aggressive financiers of Starwood, it has allowed the company to be more aggressive in making loans. In addition, the average LTV today of Starwood 63% and it has never taken a dollar of loss, a factor DiModica attributes to the structure and processes in place at Starwood.
Going forward, DiModica sees the company as growing slow and steadily with its shareholders. “We own about $1 billion of CMBS in B, BB, and non-rated that allow us to name our self as a special servicer. The rules just came into play a month ago on December 24th for risk retention, which is part Dodd-Frank, that require you to hold 5% of everything you originate to sell off into a CMBS loan. One of the things we’ve been looking hard at is how to take advantage of that and how to deploy more capital around that because there aren’t a lot of permanent capital vehicles like ours who want to hold these assets for ten years within these Dodd-Frank rules.” Starwood plans to be more aggressive in taking advantage of that opportunity given the type of capital that it has, and it will likely continue to grow its property book and its loan book, as long as the banks continue to finance Starwood as they have been.
DiModica also discussed his thoughts on what rising interest rates would mean for Starwood and the industry in general. As Starwood is a special servicer on $93 billion of named CMBS, loans defaulting is hardly something that keeps DiModica up at night. More loans defaulting mean more income earned for Starwood due to its special servicer. The low LTV and cautious nature of Starwood’s lending book mean that any losses in that area will likely be more than offset by its special servicer. “The net effect with a floating rate book is that we’ll make more money on a higher rate environment with LIBOR going up,” said DiModica. “If we were involved in fixed rate loans, that wouldn’t be the case. We have analysis in our investor deck that shows that we’ll make about seven cents per share more when LIBOR rises 100 basis points, and fourteen cents when it rises 200 basis points. On a stock that pays a dividend of $1.92 a year and earns a little over $2 a year, that’s a pretty decent portion. We’re going to make not insignificantly more in a rising rate environment.”
In addition to higher interest rates, DiModica discussed what other effects he expects from the new presidential administration. Higher interest rates, potentially higher inflation, and higher growth will cause cap rates to back up a little bit, and real estate prices are expected to follow. DiModica also believes that President Trump’s likely decreases on corporate and personal tax rates will lead to growth down the line, but he cautions people to understand that this may take longer than they expect to see the NOI growth that results from these tax breaks. “History would say that it takes a long time,” said DiModica, citing similar policies that were enacted during the Reagan administration. “If he does go after aggressive tax breaks, it could take a long time to flow into the economy. I think most of us are expecting that to happen fairly quickly- the bond market is clearly expecting that by large increases in rates.” DiModica discussed how this growth will hit hotels first and retail likely second, but office will take awhile to experience this growth due to the nature of having longer-term leases in that sector.
One of the more significant changes that DiModica thinks has a likely chance of taking place is a cap on the amount of deductions from estate taxes, real estate taxes, and charitable donations. “There’s a large effect to people who live in the higher tax states already like New York, New Jersey, California, and Connecticut, and I think you’ll see more migration from [areas with] that tax policy to places like Florida,” said DiModica in reference to this potential reform. “If I look at the 100,000 units in multi-family that our parent, Starwood Capital Group, owns, almost 40,000 of them are in Florida. We’re betting on low-tax or zero-tax states.”
DiModica provided many takeaways and insights about the future and strategy behind mortgage REITs, and the students and faculty of the Baker Program look forward to learning more key lessons from the next industry leader in the Distinguished Speaker Series.