Greetings. Welcome to Starwood Property Trust's third quarter 2026 earnings call. At this time, all participants will be in listen-only mode. The question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star 0 on your telephone keypad. Please note, this conference is being recorded. At this time, I'll now turn the conference over to Zach Tanenbaum, Director of Investor Relations. Thank you. You may now begin.
Thank you, operator. Good morning, and welcome to Starwood Property Trust earnings call. This morning, we filed our 10-Q and issued a press release with a presentation of our results, which are both available on our website and have been filed with the SEC. Before the call begins, I would like to remind everyone that certain statements made in the course of this call are forward-looking statements which do not guarantee future events or performance.
Please refer to our 10-Q and press release for cautionary factors related to these statements. Additionally, certain non-GAAP financial measures will be discussed on this call. For reconciliation of these non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP, please refer to our press release filed this morning.
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. DE was $0.31 per share in the quarter, or $0.41 excluding realized gains and losses from commercial lending resolution. In order to provide a comparable metric to commercial mortgage REITs and additional perspective on assessing the run rate earnings of our portfolio, we have added this new measure of distributable earnings to our press release supplement and 10-Q this quarter.
I will begin today with this quarter's progress towards resolving non-accrual loans and REO, and the changes in our reserves and book value before turning to our individual businesses. During the quarter, we resolved $254 million of non-accrual and REO, including the sale of two multifamily REO assets with an aggregate DE basis of $134 million for $97 million, and two units in our New York City residential project for an additional $12 million.
All sales were in cash with no seller financing. We also returned the final $108 million portion of our formerly four-rated Brooklyn office loan to accrual after securing a lease with a credit tenant and bringing the underlying office property to 100% occupancy.
In commercial lending, we have $1 billion of reserves against our non-accrual and REO assets after recording an increase of $369 million in the quarter due to third-party modeled macroeconomic conditions, which worsened as a result of the rise in interest rates. This consists of $822 million of CECL and $217 million of REO reserves, which translate to $2.85 per share that is already reflected in today's undepreciated book value of $17.22.
This book value also reflects a $0.24 reduction in the quarter resulting from the effect of higher interest rates on the fair value of the fixed-to-floating rate swaps on our corporate debt. To the extent that debt finances floating rate assets, we swap that debt to a floating rate. Over time, higher interest income on the floating rate assets supporting this corporate debt are expected to offset this book value reduction.
In commercial lending, we originated $2.4 billion of investments in the quarter, of which $1.5 billion was funded. We also funded $236 million of preexisting loan commitments. Net of $1.2 billion of repayments, the portfolio increased by $528 million to a record $17.8 billion. Turning to residential lending, our on-balance sheet loan portfolio ended the quarter at $2.2 billion, and our retained RMBS portfolio was $310 million.
We recognized a $39 million negative mark-to-market on loans net of related hedges, primarily due to spread widening. On a year-to-date basis, the net mark-to-market was just $5 million, evidencing the effectiveness of our hedge strategy. In addition, we improved financing costs on $356 million of financing lines in the quarter, reducing spreads by a weighted average 24 basis points.
I will now turn to our property segment, starting with Woodstar, our 15,000-unit affordable multifamily portfolio in Florida. We implemented the authorized HUD rent increases effective July 1, averaging 8.9%, which increased earnings in the quarter by $1.7 million. In September, we refinanced $415 million of debt in this portfolio, $35 million of which closed in the quarter and the remainder in October.
Given appreciation in NOI growth, we were able to upsize $146 million at SOFR plus 165, our $116 million share of which can be reinvested to increase future earnings. Since acquisition, this portfolio has returned the entirety of its original cost basis, plus an incremental $275 million through cash-out refinancing, providing an infinite return on our original capital. In net lease, we acquired $32 million of properties at a blended cap rate of 7.37%, bringing purchases since acquiring the platform to $556 million at a 7.45% cap rate.
The portfolio now stands at $2.8 billion, comprising 534 properties across 44 states, a weighted average remaining lease term of 16.6 years, average annual rent escalations of 2.3%, and 100% occupancy with zero defaults. Annualized base rent increased to $193 million from $187 million last quarter as certain construction assets were brought online.
During the quarter, we reduced some of the platform's overhead, helping the business become accretive to DE per share. Next, I will turn to our investing and servicing segment. In our special servicer, LNR, we continue to benefit from elevated resolution volume, which drove $37 million of special servicing fees in the quarter. Our active servicing portfolio ended the quarter at $10.2 billion, and our named servicing portfolio was $90.8 billion.
During the quarter, Fitch reaffirmed LNR's CSS1 special servicer rating, the highest rating available. LNR remains the only special servicer to hold this distinction. Finally, our conduit, Starwood Mortgage Capital, securitized $210 million of loans at profit margins in line with historic levels. Concluding my business segment discussion this morning is our infrastructure lending segment. We committed $505 million, while repayments totaled $389 million, with the portfolio ending the quarter at $3.1 billion.
Credit in this portfolio remains strong, with 100% of its loans rated three or better. Turning to liquidity and capitalization. Our current liquidity stands at $1.1 billion. This does not include liquidity that could be generated from expected proceeds from REO sales of assets in our property segment, cash-out refinancing, direct leveraging, or excess capacity to raise incremental corporate debt.
We continue to operate at conservative leverage levels, ending the quarter at a debt-to-undepreciated equity ratio of 3.15 times. Our unencumbered asset pool stands at $7.2 billion against $4.5 billion of unsecured debt, a coverage ratio of 1.6 times at quarter end, again, well in excess of our 1.2 times covenant. With that, I will now turn the call over to Jeff.
Thanks, Rina, and good morning, everyone. I want to start with the progress we are making in resolving legacy assets and reducing our exposure to loans originated in the pre-2023 rate environment. As Rina said, we completed over $250 million of resolutions in the quarter and remain on track to achieve the over $800 million resolution target for 2026 we outlined previously, which would be more than 40% of our non-accrual and REO.
We had no new non-accrual loans and no new foreclosures again this quarter. Beyond resolving legacy assets, our other two priorities remain putting capital to work in attractive new investments and optimizing our capital structure. We made progress on all this quarter. We invested $3.2 billion across the platform, including $2.4 billion in commercial lending, bringing year-to-date investments to $8.2 billion and total undepreciated assets to a record $32.3 billion.
We also made progress on the right side of our balance sheet. In July, we repaid the $500 million of corporate debt six months before maturity at its first par call date. That debt cost us SOFR plus 295 basis points, compared with an average equivalent spread of approximately SOFR plus 203 basis points on the $2.1 billion of corporate debt we issued or repriced this year, a reduction of approximately 92 basis points.
These transactions lowered our funding spreads while extending our corporate debt maturity. We also redeemed two CLOs during the quarter in commercial lending. Having access to multiple financing channels allows us to move assets between funding sources and optimize our borrowing costs. Today, we have $1.1 billion of liquidity.
Our unique access to liquidity supports our consistent and selective investment activity and our ability to manage pre-2023 assets originated at lower interest rates toward their best economic outcome, not the one that creates short-term liquidity at the expense of long-term shareholder value. Our liquidity also allows us to act on our conviction in the value of the company. In the quarter, we repurchased $108 million of common stock, bringing year-to-date repurchases to $138 million.
We will continue to weigh repurchases against new investments and other uses of capital with the same focus on long-term shareholder returns. We received $1.2 billion of loan repayments during the quarter and an additional $320 million after quarter end, bringing year-to-date repayments to approximately $2.8 billion. More than two-thirds of our repayments came from loans originated before 2023.
These borrowers were most affected by the rate rise, but continued to execute their business plans and refinance, even in office, where we had a significant paydown on one of our higher risk-rated loans. In that case, the borrower sold one of the buildings at a price per square foot materially above our existing loan basis, meaningfully reducing our exposure on the remaining collateral.
Our internal underwriting, driven by our in-house asset management team, has projected elevated quarterly repayments in line with the $1.2 billion we saw this quarter to continue for the foreseeable future. Combined with our continued and significant investment activity, these repayments should materially reduce the percentage of our portfolio originated in the prior rate environment, which stands at $8.5 billion today, representing 40% of our loan portfolio or 20% of our total assets, among the lowest in our peer group.
This percentage will continue to fall as loans are repaid or resolved and as we continue to invest in new loans, as we have consistently done. Of that $8.5 billion, $3.8 billion are rated four or five today, and $4.7 billion are rated one to three, with average debt yields of 6.2% in multifamily, 9.3% in hospitality, and 8.9% in office. These healthy debt yields help explain the repayment activity we continue to see from loans originated before 2023.
Next, I will address our CECL reserve. The 10-year Treasury rose 80 basis points during the quarter, and forward SOFR increased by 100 basis points. As we have discussed before, we use a third-party model-based methodology that incorporates forward-looking interest rates and economic assumptions. The bulk of this quarter's reserve increase was driven by that increase in interest rates.
Higher projected interest rates increase borrowers' expected debt service and can reduce the proceeds available to refinance their loans, even where property-level operations continue to improve. Our CECL model produced significantly higher reserves on more rate-sensitive assets, including multifamily loans originated before 2023. Our total CECL reserves increased approximately $337 million this quarter to $822 million, and owned real estate reserves increased $32 million to $217 million. Substantially all of the increase was in our general reserve.
Our four-rated loan balance increased $290 million in the quarter, and our five-rated loan balance increased by $440 million. All of this quarter's downgrades were on loans originated before 2023, and more than half were on multifamily assets. Given their consistent performance and rent growth, investors buy multifamily assets at lower cap rates than other CRE assets. This makes them the most interest rate-sensitive assets in our lending portfolio.
Since quarter end, rates and forward SOFR have declined, which is a positive development for these borrowers and their ability to refinance. In addition, the majority of our multifamily loans are rated one through three and carry a healthy 7% debt yield, which are refinancable in today's higher rate environment. We believe the impact of higher rates and the challenges in our portfolio are substantially reflected in our book value.
Moving on to our asset resolution process, our approach remains consistent. We evaluate the proceeds available today against the time and capital required to achieve a better outcome. Where a sale makes sense, we sell. Where operating the asset, improving performance, taking on deferred maintenance, and completing the business plan produces a better expected recovery, we have the people, resources, and liquidity to do that.
Our 300-plus person company, combined with our manager, Starwood Capital, gives us access to operating expertise and property-level information across sectors and markets, and we bring that experience directly to our assets. The objective is to maximize recoveries and recycle capital into investments that contribute to future earnings.
A good example of the value of hands-on management and patience in resolving legacy loans is the $300 million loan we originated in 2021 on a 600,000 sq ft office project in Brooklyn, New York. With the execution of the third and final lease, the building is now fully occupied, and as Rina said, we moved that piece to accrual in the quarter as a result. With the sponsor unwilling to contribute additional equity, we restructured the loan to support continued leasing in lieu of pursuing foreclosure.
Over the last two years, our close collaboration with the sponsor helped drive occupancy to 100%, with three accretive long-term leases materially improving the loan's risk profile and positioning the asset for sale or refinancing. I will note that sponsors have contributed $710 million of additional equity since closing to our four and five-rated loans, including $128 million on loans downgraded this quarter.
These contributions demonstrate borrowers' continued faith in their investments as they contribute capital to execute their business plan. I want to conclude my remarks today with a discussion on the valuation of our stock price and what one could infer the market is implying. CRE loans represent roughly half of our assets. The other half includes infrastructure lending, residential lending, our equity portfolio, and our investing and servicing business.
Some of these businesses have countercyclical earnings drivers, different financing sources, and different opportunities to create value. These assets continue to perform well, especially our energy infrastructure business, which benefits from long-term increased demand, our net lease business, which provides long-term contractual rental income and significant annual rent increases, and our special servicer, LNR, with over $90 billion of named servicing and a significant pipeline of revenue opportunities.
We have spent years diversifying and building those differentiated businesses, which have dampened earnings volatility versus our peer group through this historic rate rise, and in this quarter, which saw the largest quarterly rate increase we have seen in a century. These businesses allow us to allocate capital to the opportunities we find most attractive as markets evolve. Today, our undepreciated book value stands at $17.22 per share.
Today's share price implies a discount to that book value of $1.6 billion beyond the $1 billion of CECL and REO reductions already on our balance sheet. If you attribute that entire discount to our $4.5 billion of four- and five-rated loans and REO, the market is implying a loss of 58% on those predominantly first mortgage assets, which were all originated before 2023. Recovering only 42 cents on the dollar on loans originated at 65% LTV would imply collateral worth roughly 27% of its original underwritten value. In other words, today's stock price is implying a 73% decline in collateral values across that entire pool.
For perspective, our owned real estate resolutions in the quarter were sold at 72% of our original basis, and our owned real estate sales currently under contract are at 71% of our original basis, both well above the 42% implied recovery in our stock price. An alternate valuation approach is the sum of the parts analysis.
If you were to value the businesses outside commercial real estate lending using public market yields, today's stock price implies an approximately 20% yield on our CRE loan book, which is well above monoline commercial mortgage REITs. We believe the market is assigning too little value to the earnings and diversification provided by the other parts of our company. To conclude, we continue on our stated path of increasing our balance sheet with accretive new investments while strategically decreasing our exposure to loans originated prior to 2023.
We are on track with our 2026 resolution targets. We expect repayments to remain robust, and we continue to put capital to work in new investments. Our diversified businesses provide earnings and flexibility as we execute that plan. With that, I'll turn the call over to Barry.
Morning, everyone. Thank you, Zach, Rina, and Jeff. Kind of an interesting time to do a call like this. Every 30 days, it seems like you have a totally different picture that you're facing. I mean, 30 days ago, the 10-year Treasury was approaching 530, and today it's 487. Remember where it was at the end of the quarter. I think I want to step back a little bit and talk about real estate asset class as a whole, because with all the chaos of the interest rate markets and the volatility in politics, real estate is healing.
The underlying asset classes are getting better and better at an increasingly better pace. Just yesterday, CoStar raised the rent growth for apartments 50. Actually have office rents going up almost 3%, 3.5%. You also have industrial rents rising 2%, and the actual print for the quarter was 3.5%.
Because of the reduction in supply, which is only going to fall further because of the rise in interest rates and the rise in construction costs, and some of the inflation in construction is coming from the, well, heretofore, the data centers stealing all the construction workers and paying them two, three times what they were making building commercial office buildings.
For the first time in history, we had more data centers being built than almost all the other asset classes in real estate, particularly the office markets. I think you have to look at that as the foundation of our book. We are a $32.3 billion enterprise. Our nearest largest competitor is 17. We are more than twice the size by equity, more than 2.5 times their scale.
You look at what has happened to us, if you take the longer view, several of our competitors have actually left the playing field. Apollo just is liquidating its commercial mortgage REIT with a dividend and the sale of a few remaining assets. There are several others that are studying their future. They are sub-scale, and they do not have the diversification that we have.
At least in the public sector, we are still one of the biggest gorillas, and we have adequate liquidity and an incredible mix of array of businesses that will power us through this turbulence, which I think might be the best way you can describe it. The impact, again, of higher rates, the beneficial impact is less supply, and less supply means better outcomes, we think, for rents rising across the landscape of our asset base.
That is also true in asset categories like senior housing, which have less than 1% new supply, student housing, and hotels, where you see pretty robust numbers coming out of the higher-end assets, especially luxury. A turnaround now at the bottom end of, which is slow, but we have not seen a positive move in the lower end of the markets for several years as construction jobs increase, reshoring creates manufacturing jobs, extends to say hotels, begin to get pricing power again.
Again, with supply being hit, this should get better and better. In the meantime, we have to deal with what we are dealing with today, which is higher rates, and much more importantly, a much higher forward curve. I continue to say, and I said it on CNBC the other day, that I do think Kevin Warsh and most of the people talking on TV are knuckleheads, in the sense that rates are not working on this economy. Maybe they worked on a different complexion of economy.
They do not work on this economy. What is actually going to slow the economy is the credit crisis in data centers. When CoreWeave's bonds are trading at 15%, you cannot build data centers. The neo-clouds face some serious issues, as does Oracle. Look at their credit default swaps, spreads. The markets are breaking themselves, and it has nothing to do with Warsh's quarter point or next December, another quarter point increase. Also, raising rates is not opening the Straits of Hormuz. It is not going to make foreign buyers jump for joy and buy our debt.
We've pissed off most of the world. This economy created 5 million jobs since the Fed raised rates 500 basis points in the three sectors of the economy that are growing the economy there, which are healthcare, education, and government. In fact, manufacturing, which is impacted by higher rates, no doubt you won't buy your refrigerator if we even make them here anymore, washers and dryers.
That part of the economy is 12 million of 160 million jobs, whereas the healthcare, government, education is nearly 50 million jobs, and they're not impacted. In fact, those industries added jobs in the GFC. You can't use this. What you do create a victim, which is the federal government, which has to pay ever-higher interest expense on an ever-increasing deficit. It does hurt the housing market, and it has hurt real estate.
Obviously, higher rates have made our borrowers think they cannot refinance and get us out even on our loans, across not just us, across the whole country. You've seen a dozen BDCs lower their dividends. You've seen every mortgage REIT to date, other than us, lower their dividends, because they're all nervous about their borrower's ability to refinance us. You have to question the V in an LTV in this rising interest rate environment.
Again, I think my guess is, if we continue to see the weakness given the Democrats' very impressive performance in the election, that you will see We already saw the moratorium. The market hadn't really corrected for it, but now it'll be harder, it'll take longer to get data centers completed. They'll be more expensive to build.
They've already changed dramatically the return on investment, because you have to provide power on your own, or you have to provide LCs for the power that you're taking through a take-or-pay contract. Only the big boys can play. Supply was going to come down anyway. It won't happen immediately, because there's stuff being built today.
You'll see it in the markets anticipating with the chip stocks, the future of the economy slowing, GDP coming down. If that happens, rates come down. I think that's going to be a very sunny day for us in the real estate property sector, because I think rates will come down with a slowing economy. Again, it didn't happen because Warsh raised rates a quarter point. It happened because the credit markets couldn't handle the scale of the spending and started to differentiate and question the credit quality.
Probably the most important event of the fourth quarter will be the Anthropic IPO coming in a few weeks. That will stabilize or destabilize, I think, some of this AI spending. Half of the backlog of Oracle is to OpenAI, nearly $350 billion. As goes them, will go probably the expansion of the data centers for a while.
This technology is real. It will change the world, and it's just a hiccup. I think you started the auto industry with 90 car companies. You wound up with half a dozen and then three. You're seeing the same thing in this business. You will have survivors, big balance sheets, big capital. It will happen, and it's critically important we put the infrastructure in place to compete with foreign capital. If we don't, many of these data centers will go offshore.
They won't go to space anytime soon, by the way, but they'll go offshore. They'll go to Europe, where you have power, or China, unfortunately, or Australia and Japan. We actually are active in all these markets, so we can tell you the demand is shifting already, as they don't have the opposition that you've seen in the U.S. rise up. Nobody really can tell you why it happened, but it did happen very quickly. Right now, I'd say, I think one of the things you saw and we don't know about is, what will happen to the job markets? I think nobody, the jury's out. Will people be able to hold their jobs as AI spreads?
I think what you saw, America was saying, "Let's slow down AI because I'm going to lose my job, and only the wealthy will benefit from this AI boom." They don't own an interest in OpenAI, Anthropic, and data centers. I think at times like this, you see a significant price discovery taking place. Right now, we're going to sell stuff, and we're on the equity side, obviously.
We've seen some of our multi sales hold their bids, and we ourselves were bidding on industrial in Europe and repriced the deal down 10%-15% because with higher rates, to get the same IRR, you have to lower the price. Some buyers are saying, "Okay." Some buyers are saying, "I'll just wait and wait for a rainy day." Even the German Bund has dropped 30-40 basis points now, so global rates are shifting down.
I think the market's also anticipating that rates are mostly a function of inflation, and I guess the strength of the AI spending. But inflation's been driven almost entirely in Europe by energy prices. If there is a resolution to the Iran situation, whatever that may be, and oil flows, I think most people expect oil to drop quickly.
Even though you read about some of the disruptions in production, I do think you'll see, and then you can see it every time there's a hint of a resolution, you see, and with oil prices coming down, inflation comes down, all the answer, pieces of inflation impacted by oil prices come down, rates come down, the forward curve shifts, and we're going to be smiling.
Right now, with price discovery unclear and rates much higher on the short end and the curve shifted higher, many borrowers are definitely hurting. What you have is two things that happen. One, they stop investing in their assets, because they feel like they're just putting money into the debt. So, if it's a multi, maybe they don't turn the unit, or they don't do the pool repairs, or they don't fix the broken equipment in the gym.
If it's an office building, they don't have the TI, they won't put the money for the TI to bring the tenant in the building, because you're just putting TI for the borrower's case. Starwood is uniquely positioned, really, to handle all this stuff. We are in the midst of converting an office building we took back.
A very large public company gave us the building back after losing $150 million, and we are converting it into a residential project, and we are on our way, and we expect to make money on an asset if we sold, we would have lost probably close to $100 million because somebody else would have to do the work. We can do that work, and we can take over a multi, and we can finish the pool, get the pool furniture, and then we will sell it, and we have done it successfully now for years, and it is actually our core business is REO. I think when you look at our company, you have to really look at the nature of what we do.
We have $3 billion of assets that we purposely bought, including our significant multifamily portfolio we call Woodstar, which Rina told you, we have a $1.5 billion gain, and we have no money in the deal. We have also expanded the cap rate on that portfolio from 4.2 to 5.2, and it has been able to hold and keep its value gains because of the dramatic increases in rents.
Do not forget, we have no real estate taxes in that portfolio, so that is not going to happen. You pay no real estate taxes in affordable, so it is just expenses and earnings growth. Expenses are not real estate taxes, which is an area that has been a bit of a black eye for a lot of real estate owners as municipalities try to balance their budgets, increasing real estate taxes.
Real estate actually does turn into a safe haven in volatile times, and it was not very exciting. Real estate is boring, and when your tech stocks and your chip stocks are rising 50 points a day, we are kind of a boring sector of the market, but we are a reliable place to convert ordinary income into capital gains, and we expect investors in every, this is my fifth or sixth crisis. I mean, usually, you always get capital flows back into the real estate markets. You can see that because our parent company just raised a $10 billion fund.
We did not think we would reach that, but we were able to get there because investors said, "Hey, this is a good time to invest in equity real estate." That is actually good because there is capital to clear the markets when the We are in sort of, again, the lap car is on the track at Daytona, and we are waiting for the race to go again.
But there is capital, there is dry powder, and there is interest in this asset class globally because the fundamentals underlying the asset class almost all over the world are actually getting better. I will say one last thing. Selling assets in this environment because of the bid-ask spread takes longer. Again, we are not distressed. We have plenty of liquidity, we have got great earnings power, we have a lot of other businesses doing fine. I'll highlight again our energy infrastructure business, which is a powerhouse business for us, and has, I think, a loss ratio of 99%.
99.6% performing, and it's really an incredible asset to our firm and provides solid footing for us going forward in an area we continue to work to expand. It's been so good that it's actually repaid faster than we wanted, and even today, you saw repayments in the quarter. There is liquidity. I should have mentioned that spreads in real estate really haven't blown out very much. But we have competition when AAA for the hyperscalers are trading 30, 40, 50 basis points wide. You have competition for capital, but real estate in the credit markets is reflecting the quality of the asset base today.
Lending spreads are at the tight of the year right now.
The lending spreads are at the tight of the year. I didn't know that, but I knew they were tight. I think the credit markets are always sort of ahead of the equity markets, and the equity markets are nervous, but our ability to refinance our debt and drive the enterprise forward is great. But we have to be realistic. I mean, we're probably not going to be able to resolve some of our assets as fast as we hoped.
We expect to hit the $850 million-ish that we told you about for the year. Most of it's already complete or about to close, so that will happen. But we may get other assets that we have to deal with, and we'll manage those as we go forward.
Given all these uncertainties, I think we will have to examine what we're going to do with our dividend, which has been paid well above the DE rates, the earnings rates we've been producing the last couple of quarters. I did think, as we looked out, we could see what we expected to be the resolutions of our asset base, and we were fairly confident we'd be able to restore earnings power, but I think there is a question of prudency.
Should we reduce the dividend and then increase it as we get the earnings power off of these underperforming legacy asset base that Jeff talked about? Most of this is from the assets we had, almost all of it is from assets we had pre the rate rise. But it's only 20% of our total asset base today, and obviously all of it's not impaired.
We will have a meeting with our board and discuss this and figure out a rate that we think is I think the market obviously is expecting it, look where our stock is trading, but I don't think the market appreciates the, again, the diversity of our enterprise. Everyone's fired up. I mean, it'll be a great opportunity for going forward to continue to extend our business, grow our business.
I do think as we resolve some of these loans, we will definitely have the ability to restore our earnings power and the dividend again. I'm not sure if many of our peers will be able to do that. Anyway, I think that's and we also can use our depreciation shield, which allows us to actually have a lower payout ratio. Again, our goal is long term.
We're all major shareholders of our own company. I have to say, I've never sold a share. It hurts me to do anything to the dividend, but I think the right thing to do is navigate through this valley, and I think you're going to see some pretty good sunshine ahead for us. With that, we'll take questions.
Thank you. We'll now be conducting a question and answer session. We ask you please limit yourself to one question and one follow-up. To ask a question at this time, press star one on your telephone keypad, and a confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Thank you. Our first question is from the line of Don Fandetti with Wells Fargo. Please proceed with your questions.
Hi, good morning. Could you talk a little bit more about your thinking in the reserve and provision? I am just trying to get a sense. Obviously, the Fed could raise again, maybe another one or two times. What is sort of built in there, and do you feel like you kind of leaned in here to catch and sink, or is this the type of thing that we will just kind of see like a couple quarters of higher provision, kind of like we have seen in the past with the pandemic and other periods of time?
Thanks, Don. Hope you are well. As you know, our CECL was kind of allocated to our fours and fives, but in terms of where rates are going, our CECL is also run against forward interest rates. With Fed funds expected to go from 3.75% on March 1st, let me put some perspective. On March 1st of this year, the first day of the war, forward SOFR for the end of 2027 was supposed to go to 2.9%.
As of middle of September, it was up to 5%. But right now, today, it is saying it will be around 4.45% or 4.50%, up from 3.75%. The Fed is pricing in, the curve is pricing in more rate hikes, but our CECL model, with the reserves we have today, are already using that because we use forward SOFR. The CECL model, as we told you, is 90+% allocated towards our fours and fives, where we think the most difficult assets will come. As I said in the prepared remarks—
That is a, if you can hear me, I know we have these trouble with these mics. That is sort of an internal allocation in our minds. It is not a specific reserve, but we look at those and say, "Okay, that covers that." Just for the benefit of all of you, which you know, but I will say it anyway in case there are people of less sophistication on the phone, we do not control the CECL reserve. It is a mechanical exercise, and we put it into a machine, and it pops out what your CECL reserve is. So, it is what it is. We take what it says, and that is what happened to us this quarter, and that is most of what you saw in the hit to earnings.
I think, Don, what you are asking is where do reserves go from here? We cannot tell you, because if we looked back last quarter, we would not have expected this level of reserve build, but then we had the rate move. We are going to take a look as we go. We have a very healthy debt yield, as I said, on our one through three rated, the ones that do not have the bulk of that allocated sort of reserve. We have very healthy debt yields on them, as we said. Hopefully rates stabilize, and we can get to a top here.
Got it. On the multifamily, I mean, Barry's comments about supply going down with the rate rise is a good point. Are you still feeling like when you take these multifamily assets back that you can sort of, the value is protected and ultimately come out of the other side-
You know-
break even or higher?
Yeah, I mean, the chips, we have 374 million shares outstanding or something like that. You are talking small losses, if they are losses at all. It is $10 million here, $8 million here, $3 million there. It is not really that material in the scheme of things because we are so big. That is one of the reasons I said you have to keep in mind how big we are.
Rina talks about $400 million or $300 million, or Jeff talks about that. We are a $32.3 billion balance sheet. We are not a $1 billion, $2 billion balance sheet. We got a big balance sheet. It is the reason I mentioned it. I am not really worried about our multi book, and I actually we will make more money likely if we are it really depends on where the asset is.
I can tell you, because we just agreed to sell half a dozen multis in our equity book, I was expecting price cuts, and some have sold at a 5.3, a 5.5, one is below a five. People are buying the future now, and it is a good asset in a good market. If it is really crappy stuff, you are talking 7s. It really goes to the quality of what you lent against also, which you guys cannot see.
Overall, I am not really worried. We will have defaults in our multi book because that is where they just do not have the money typically. They have gone back to their LPs. They have gone back for one refinancing or two or small pay downs, and it is all taking much longer. Look what the curve looked like. We were expecting a three forward curve.
Against that, then we had a war in Iran, and we had the tariffs, and the tariffs halted Powell's rate cuts. He said, "I want to wait." Inflation did not show up really, but we all thought it would. I think the average man thought it would. Then you had this very powerful AI boom, which drove GDP growth, and then we had the war, and inflation just took off and went the other way again.
Rates followed that. If you are a multi guy, you were expecting that the world would get better faster. Now, some markets are not great. You can look at the publics and see the different returns of the different geographies. The portfolios on the coast are doing better than the sunshine states. We are seeing green shoots.
We are seeing some of the south, the smile states, the Texas, Tennessee, Florida. We are seeing city by city. You are beginning to see, you see it first in less concessions, and then you see it in lower lease trade-outs. All of us, if we are renewing a tenant, we are getting rent growth. It is the new tenant that we are the lease trade-out where they went negative. Overall, I think you are positive one or two or something like that.
Again, it is city by city. It is definitely trending the right direction. Again, because housing is getting hit hardest by the rate increases, new construction of single family homes is going to collapse. It is falling. It is not actually collapsing. It is just down. Because the balance sheets of the builders are so good that they can continue to subsidize mortgages for buyers. I think the press has gotten it slightly wrong.
Their margins are coming in as they offer more and more, have to come up with concessions in the form of mortgage buy-downs. But the balance sheets of the home builders that are left, and they now dominate the market. In previous period, they did not. But now these giant builders are like 60% of the housing market. I think overall, it is going to be a brighter future, for sure.
Thank you. The next question is from the line of Jade Rahmani with KBW. Please proceed with your questions.
Thank you very much. Distributable earnings, excluding realized losses, came in at $0.41. I just wanted to get your thoughts weighing the puts and takes, timing of loan closings, repayments, and where rates are today. Do you think there's upward or downward pressure on that?
On the $0.41, Jade, if I look back to Barry's comments earlier, last quarter, as he said, we looked out in that rate environment, and we had a path to getting to the $0.48 that we said we were paying out with the new higher rates.
In a few quarters.
In a few quarters, yeah. Being at 41, I think our projections would be a little bit higher, but that is based on what we know today and not what we do not know yet that could happen. Yeah, our projections are there or a little bit better, but-
I think you can use that as sort of a base earnings rate. We have a lot of levers, right? We have a lot of things we can do. I think that is a reasonable number, and hopefully, as I mentioned, it goes up as we restore our and can put this capital back to work at the kinds of returns we are getting in the stuff we are doing today.
Obviously, in retaining capital, in creating capital, will allow us to get that back up, Jade. The two things that are important are reducing non-accruals, which we are making progress on, and continuing to grow. Our pace of growth has been really good, so if we can execute on that, our plan is to get this back up to where we had hoped it would be last quarter on the run rate.
Okay. The second question is just the CECL reserves, you noted the increase was mainly a macro model. It was a general reserve, no asset-specific changes, and no new non-accruals. It is kind of like a model formulation.
That is correct.
At the same time, we did see risk four and five rated loans increase, but we saw NPAs decrease. The question is, if despite what the model suggests, are you seeing any new indications of defaults or non-performance so far in the fourth quarter?
Yeah, listen, as you headed into September 30, the ultimate high in rates was September 30, right around there that week. If you look at the fours and fives, it was people trying to make a decision on a five-ish debt yield multi, do I continue to put money into that asset, or do I hand it over?
Given that we thought the market might start capitulating, we definitely more cautiously moved people at the end of the quarter, which is when we mark the book, to more of a four or a five stance. I would expect that we are able to work out of fours and fives as quickly as anything new comes in.
We don't know the full effect of the September, October rate highs, but as rates moderate to where we are today, I would expect that there's a significant decrease in a stop. Remember, we didn't have any new REOs or foreclosures for two quarters in a row. This move in September really drove us to make some moves on some of the lower debt yield assets that moved up to the four and five category, and if rates moderate, who knows? They could pop out.
Just some of the multis in particular, they're just toggling, right? They're just sitting at debt yields where you thought they would clear, and then when rates go up, they won't clear there. Maybe the 5.5 is now a 5.75 or a six. Nobody knows, because actually we don't have them back, but Rina has a significant, I would say, 40%, 30% of the resolutions are us taking the multis and selling them, something like that.
This quarter we had two multis that sold. There were two multis that sold, and there was one office that was converted to, call it other, that was put on accrual, so that resolved.
Yeah. Again, you have to remember, people are buying down cap rates in asset classes like senior housing because I don't know if you can hear me. People are buying down cap rates in assets like senior housing because they're having 5% to 7% rent growth, and so you've seen that translate into cap rates. But those prices are holding even with higher rates.
And there's infinite demand at the moment. You see that reflected in the prices of Welltower and Ventas. I mean, it's really a good business right now. If we get this recovery in multis, cap rates will come down, because people will buy the future growth, which should Don't forget, your attachment points when you're buying these assets are fractions of replacement cost. So you have a reasonable runway before you're going to face what I call material new supply.
I just saw the stats on multis in 2027, they're coming down. Even if you thought it was getting built, people aren't going to build them because the cost of capital has gone up. We're trying to, in every asset category, trying to figure out what's actually getting built. And the office markets are kind of extremely odd.
You have the best buildings 100% full in almost every city in the world, and almost price insensitive on rents. There's a new building going up in Manhattan, of all places. I think they're going to break $400 a foot. That's $200 higher than you saw five years ago, $200. And the market is 18% vacant, but people want the best stuff, and they're willing to pay for it.
It's hard to underwrite, because if you have one of those buildings, well, it's hard to What's the exit cap? What's the cap? If you're not in one of those buildings with the cap, I'm guessing it's a 200 basis point difference, maybe three. It's a complicated market right now. But it is healing, and it's not like things are getting worse.
Things are getting better, other than rates. I kind of like the slowdown in the economy. I kind of think it's just fine. 1% or 2% GDP growth is wonderful, especially if it's driven by wage growth. And hopefully, we'll get some of that. It'll be interesting to see with the Democratic sweep, wages and what happens with union wages in large cities.
Could be very adverse to some asset classes that have a big component of their cost structures in labor, like hotels in major cities. The unions were pretty robust before this happened, but holy moly, it will be interesting now.
Thank you. The next. As a reminder, to ask a question at this time, you may press star one from your telephone keypad. Our next question is from the line of Gabe Poggi with Raymond James. Please proceed with your questions.
Hey, good morning. Thanks for taking the questions. Barry, Jeff, I wanted to go to the stock price comments you guys laid out, right, and the sum of the parts and the size of the business, et cetera. What levers, if the market just refuses for the time being, right, hopefully not forever, but the time being, refuses to kind of see the sum of the parts, what levers are you guys considering pulling to try to highlight the sum of the parts? You obviously bought back $108 million of shares in the quarter.
Is that something you pull on? Is there a potential to rotate out of the residential business, right? You've got equity stuck there to go buy back more, to go do more accretive investing. Just help us out there.
Yeah. I mean, if you were an equity REIT, if we spun off our equity assets, we would create value, presumably, because they don't trade like they trade buried in our sole.
Can I start with a different place rather than what things we might do that way? Gabe, I think one of the great opportunities in this market today is, I think there'll be M&A opportunities. I think there'll be M&A opportunities across a lot of REITs that do residential or commercial or other. Although our book value isn't where we Our price to book value isn't where we want it, I actually think it could be accretive still.
When I spend time with Barry, it's more about how do we grow the business than how would we unlock We obviously want to unlock hidden value in any of these businesses, but I think that the focus is more on growing. I actually think we have a great opportunity to grow the business today, given the way a lot of these names are trading. There are some things that we don't do that I think we could do better. Now, Barry, if you wanted to talk more about the existings, but I just wanted to put a perspective on that.
No. Again, I mean, our triple net lease business, you have multiple examples of companies trading at 4.5% to 6% dividend yields, and in ours, you are double-digit dividend yield. We have to look at all these things. We are on it. We are also looking at acquiring things still, but it is a little trickier, because we are trading at such a discount to book.
We have to do discount to book to discount to book. We have to do a share deal that reflects the enterprise value of both enterprises. But there are people throwing in the towel, and maybe we can find something interesting. We have had our sights on a few things for a long time, and one of them just did something interesting. We are going to pursue things that we think will create long-term shareholder value.
Thank you for that. I got one follow-up if I can. I think you guys get asked this every quarter, or at least every quarter in 2026, but considering the rate move, I figured I would ask it again. Obviously, Starwood Capital Group owns a lot of multifamily. Starwood Property Trust has a lot of multifamily exposure. Rate volatility has happened.
Things are harder to pencil, as you guys have discussed for the last 54 minutes. Barry, is there an opportunity at the REIT with the REIT's exposure, either to cobble together, and I am thinking out loud, third-party capital to own more multifamily outright in the diversified REIT? Because that may be very well a better total return over time to own the bricks than to be the lender.
It may be. Yeah, I mean, we control 110,000 apartments in our various vehicles. This is 17,000 of them. They are all affordable. They are all in Florida, actually. Yeah, I think actually partnering with outside capital in our various verticals to leverage and create value for the parent is a viable strategy. I would rather go into more higher ROE businesses, frankly, and balancing that against the fact that that income is not qualified income.
But we have those businesses today, like our servicer, and we think there is a lot of pain, obviously, across the sector and across the real estate world right now. So, it should open up interesting opportunities for us. If we see something compelling, we are going to do it.
Gabe, when we added the portfolio, it was basically six caps financed at four that gave us a 10% cash return, and ultimately that paid our dividend, which was 8% or 9% at the time, so it was a layup when we added the first $3 billion. Today, it was low five caps. You cannot finance them inside of there, so we cannot really create a cash return that would cover our elevated dividend today. So it is a hard time to leg into multis, as much as I think we think the performance will continue to elevate. Hard time to leg into it here for a cash pay, dividend pay instrument like Property Trust.
Thank you. Next question is from the line of Chris Muller with Citizens. Please proceed with your question.
Hey, guys. Thanks for taking my questions. I guess given the shift in rates and pick up in CRE and property valuations, how are you guys thinking about the special servicing business going forward, and how quickly do loans typically move to special servicing after we see rate shocks like we saw in the third quarter?
Yeah, thanks so much. Typically, an asset's going to sit for an average of 12 to 18 months within the servicer. As I look at this stress, it really sets us up well with 90 billion of named servicing and over 10 billion in-house today. It really sets us up well for good revenues into later into 2027 and early 2028. Rina and our base model doesn't really change those that much based on where we know the stress came out in that 12 to 18-month timeline that I just said. But typically, an asset will sit here. It takes us a while to get our arms around it and figure out the best disposition path.
The distress that I think will be the highest level of distress will probably be these September rate highs, and that should lead to late 2027 or early 2028 significant income growth. But that's about the timeline.
Got it. That is very helpful. I think it was on the last call, Barry said that he was hoping for more momentum in the net lease business. As you guys talked about, rates have shifted pretty dramatically since then. Just any updated outlook on the net lease business would be very helpful.
Well, yeah, we are a little boxed out right now. Our cost of capital is a little high. We are working on finding attractive opportunities. We want to continue to invest. We have had to right-size some of the overhead we had in the business, but it made money for us this quarter, which is a first.
And will continue to.
And will continue to increase since 100% occupied in 17 years or something like that at WALT. So, we are going to give it a real good shot, but it actually is a business that either should raise outside capital or spin out from us. If we cannot give them the cost of capital, they need to grow their business. I think it will be accretive to us, either of those. Increasingly accretive. It is about a roughly $3 billion business.
It is a total enterprise. I think it is large enough to stand on its own if we wanted to do that, and we will have to examine whether that is a smart thing to do or not and how that would work. But the team is talented. They are veterans. Most of these people were in public companies before, and they know what they are doing.
We hope it becomes a more meaningful part of our asset base and contribute to our earnings. But again, I mean, it's not adding enough value or can't grow as fast as we'd like it to grow, given our cost of capital right now.
It's a brutally hard market for them. Sale-leaseback volume has fallen off a cliff in the last year and change. Our financing costs, we have an ABS structure, but as you guys have seen, ABS senior spreads have widened a bit in addition to the base rates being higher. So, it's harder to finance, and there's less to do, and rates are up.
I think we get a little bit of rate stability in around where we are today, and you'll start to see sale-leasebacks happen again, and I think we can really start to grow that portfolio. But in addition to all those, you've had a number of our competitors in the year since we bought this last July come into this business. So, there's more competition. Hopefully, we end up getting more volume. We have the right team to execute it, and we definitely want to grow it. It will continue to benefit from these large annual rent bumps for the 17-year lease.
One of the things we would like to do is expand their catchment basin. One of our peers has gone into the business and not doing just sale-leasebacks. Again, it's all tied to interest rates. One good thing is rising rates means we can buy, what, sevens or trading at eights. Again, there's a bid-ask spread. People don't want to trade it at eight.
So, if the cap rates back up, we'll be back in business, given it's all about the spreads. We're a big enterprise. We'll have a quarter of slowdowns, and then we'll pick up again. That's why we have eight cylinders or something. So, this one is having a timeout, but it's no longer dilutive, and it'll get accretive. So, that's good.
Thank you. At this time, we've come to the end of our question-and-answer session. I'll hand the floor back to Barry for any closing comments.
No, I wish you all safe trading and investing in this turbulent time. It's going to be amazing. The lame-duck period until Congress is sat could be fascinating and wild. Then we'll see what the Democrats decide to focus on, and if they drop the ball or take the ball and move the country in a better place. We wish you all a happy Thanksgiving, and we'll be talking to you again in three months' time. Thank you.
Thank you. This will conclude today's conference. We disconnect your lines at this time. We thank you for your participation. Have a wonderful day.