Debt Pioneers: Starwood Property Trust’s Brain Trust
Carl Gaines Dec. 4, 2012, 2 p.m.
This past October, after three and a half-weeks of negotiations, Starwood Property Trust and a fund controlled by Starwood Capital Group originated the REIT’s largest transaction so far—$475 million in combined acquisition and construction financing for a joint venture to develop Times Square Gateway Center, a 340,000-square-foot multi-use complex in the busiest area of Manhattan.
After a run of about three years, Starwood Property Trust, which real estate investor Barry Sternlicht took public in August 2009, has “entered the big league,” as FBR Capital Markets analyst Gabe Poggi wrote in a report after the release of the REIT’s third-quarter 2012 results.
The country’s largest commercial REIT, with a market capitalization of $3.1 billion as of November 6, closed $599 million in new investments in the third quarter and an additional $482.3 million of new investments since October, with many more in the pipeline due to close by the end of the year.
There are at least two very powerful “secret weapons” behind these results, it emerged from a series of interviews the members of the executive team running Starwood Property Trust had with The Mortgage Observer.
First, the REIT benefits from “major synergy between the Starwood Capital Group equity team and the debt team of Starwood Property Trust,” said Mr. Sternlicht. This synergy was fully employed in the Times Square Gateway Center deal, which was sourced and closed by Marcos Alvarado, a senior vice president at Starwood Capital Group and a fast rising young star on its acquisitions team.
Starwood Property Trust’s other ace in the hole is an executive debt team that has been together for almost two decades—through all the ups and downs that commercial real estate finance has seen in that period.
President Boyd Fellows, Chief Financial Officer Stew Ward, Chief Credit Officer Chris Tokarski and Chief Originations Officer Warren de Haan were hired by Mr. Sternlicht in October 2010 to form the executive team of the REIT, along with Chief Operating Officer and General Counsel Andrew Sossen—who had been hired in 2009.
The team’s story dates back to the origins of the CMBS market. “We’ve been together for an incredibly long time—we act as a team,” Mr. Fellows said. He estimated that the team has closed roughly 5,000 mortgages in its entire history together.
After years of shared careers and lives, the team’s bond goes well beyond its professional relationship.
“Ultimately,” said Mr. de Haan, “we love working together. We trust each other implicitly, and as a team we are stronger than we are individually.”
Mr. Fellows and Mr. Ward were the first to meet, back in 1983. Originally from St. Louis and Denver, respectively, the pair were just out of their M.B.A. programs and had landed jobs in the treasury department at Bank of America in San Francisco.
Both outdoorsmen, location was a key factor for them in those early job decisions.
“Both of us were interested in jobs pretty much only in San Francisco or Denver,” Mr. Ward remembered. “Places where you could ski and ride.”
The group still pursues a shared passion for outdoor sports, which was among the reasons for choosing California as a base, though, in fact, the team is spread across multiple locations. Mr. Fellows, Mr. Ward and Mr. Tokarski are based in San Francisco, Mr. de Haan is in Los Angeles and Mr. Sossen commutes between his Upper East Side home and the Starwood office in Greenwich, Conn.
Messrs. Fellows and Ward’s work in real estate lending began at Morgan Stanley. From there, they moved to Nomura in the early 1990s, where they were among the pioneers of the CMBS market.
Being a pioneer meant all the attendant room for creativity while developing those early sophisticated structures. “It was like the Wild West,” Mr. Fellows asserted, speaking in a New York café on a snowy morning in early November, just before hopping a plane back to San Francisco. “We brought a huge amount of what I would call science to the process, in a real estate world that had never experienced this kind of rocket-science-based lending.
“We invented a lot of structures,” Mr. Ward said a few days later, as the entire team met in New York for a busy schedule of meetings. “Simple things that today people don’t even think twice about.”
For example, the notion of defeasance to pay off the mortgage early, he said, was “something that Boyd thought [up] on his own.”
Mr. Fellows was one of the key senior executives who led Nomura’s CRE division and helped grow it from just 12 employees to 450. The partners call Mr. Ward “a quantitative genius” or “a legend,” who is credited for many of the structural innovations that shaped the securitization of commercial real estate debt in the 1990s.
“It was the right time and it was the right place. The group was built very rapidly but was built with some of the smartest people that I’ve ever met and worked with,” said Mr. Tokarski, who joined Nomura’s CRE division in 1995 and, as a director, ran the commercial mortgage underwriting and securitization group. Originally from New Jersey, Mr. Tokarski earned a B.A. from Brown University, where he had distinguished himself in wrestling. His partners said this activity prepared him for his current role as a credit officer, negotiating with originators and borrowers.
However, the Nomura experience came to an abrupt end when the 1998 Russian debt crisis led to an almost overnight collapse of the CMBS market. Following huge losses, the Japanese bank exited the commercial real estate lending market.
“We were fully aware of the risks that we were taking, and we had full support from the management of the firm, but there was no derivative markets per se and there was no way to hedge that exposure,” Mr. Ward said. Five years later, when the team started a CRE lending platform at Countrywide Financial Corp., it remembered lessons learned from Nomura. “We took an incredibly disciplined approach to hedging and risk management, and I think we were arguably the only major CMBS player that didn’t lose a penny during 2007 and 2008,” Mr. Ward added.
In the meantime, the team had added a new member. Born and raised in South Africa, Mr. de Haan graduated from the Hotel Institute Montreux, in Switzerland, where he met his Italian-born wife. He worked in hospitality in London before moving to the U.S. to attend the Cornell University School of Hotel Administration, where he studied real estate and finance. His first job in CRE finance was at Nomura’s New York-based large loan team.
When the division moved to California, he recalled, “Chris, Boyd and Stew were already in San Francisco, and we became very good friends.” Once again, skiing and mountain biking helped cement professional relationships into friendships.
When Nomura shot down its CRE lending division, it seemed fate was pulling them back to New York. “We decided we didn’t want to leave the West Coast and go back to New York,” said Mr. de Haan. “This is when we hooked up together and we did a lot of advisory work.” Even for Mr. Tokarski, at the time the group’s only East Coast native, relocating was not a question. “I moved out to California and I love it,” he said. “I’ll never come back.”
By then it was evident that the quartet’s skill sets created a complementary and powerful team. “When we talked about going to Countrywide, we viewed it as a very good opportunity for us to use our combined experience, relationships and skills to build a very scalable business,” Mr. de Haan said of the group’s decision to head to the company in 2004.
All four initially joined Countrywide as executive vice presidents. Mr. Fellows was on the management team that founded and built Countrywide’s commercial real estate business, Mr. Ward was responsible for all capital markets activities and risk management, Mr. de Haan oversaw national originations and Mr. Tokarski was chief credit officer.
“We built Countrywide’s commercial real estate business from scratch,” Mr. Fellows said of the division that became one of the largest in the United States, closing over 100 loans a month at its peak. “One thing we always brag about is that we are the only CMBS team on the entire planet that didn’t lose money in 2007 and 2008,” he added, echoing Mr. Ward’s sentiment.
Nonetheless, with the financial crisis, Countrywide Financial was sold to Bank of America in 2008, and the CMBS team was let go. “It happened to a lot of firms at the time,” said Mr. Fellows. “We went back to start our own business again—Coastal Capital.”
The team could have gone ahead with its own business, but around the same time, Mr. Sternlicht was making moves in the commercial real estate lending market. In 2009, he launched Starwood Property Trust, a publicly traded investment bank that invests in and originates commercial real estate debt. Its initial public offering raised $950 million.
Mr. Sternlicht had known Messrs. Fellows and Ward since 1994, when Nomura provided the financing for his $561 million acquisition of the Westin Hotel Co. from Aoki Corp.
On a recent phone call with The Mortgage Observer, Mr. Sternlicht recalled that he had once worked on a hotel financing transaction with Mr. de Haan. Mr. Tokarski, meanwhile, was on his radar as a fellow Brown University alumnus. “They were very well-known in the debt space,” Mr. Sternlicht said, noting that the group’s cross-country lending relationships made it a good fit for the REIT.
“He raised the capital, but he needed a team. We were a team, but needed the capital,” Mr. Fellows said. “I can’t remember how many people he hired at the one time, but probably about 15. And—bam!—that was able to turbo-charge the REIT, which grew much more quickly and handled many more transactions.”
Once at Starwood Property Trust, the debt team acquired its fifth member. Originally from Upstate New York and with a law degree from the University of Pennsylvania, Mr. Sossen had primarily practiced mergers and acquisitions and securities law in New York for almost six years. Since 2006, he had been general counsel for the REIT KKR Financial Holdings, based in San Francisco. In 2009, Mr. Sossen heard through the grapevine about a position with Starwood Property Trust’s senior management team. “I flew to Greenwich to meet with Barry [Sternlicht], and four to six weeks later I quit my job and I was moving back to New York. Barry is a pretty persuasive,” Mr. Sossen said. “I got very intrigued, because it was never the understanding that this was going to be a small little player. This was going to be a significant player in the real estate finance industry—a big operating company.”
The original four members of the team agree that Mr. Sossen’s strong corporate background added a lot. “It can be very difficult and quite intimidating having four guys who have worked together for such a long time coming in as your partners,” Mr. de Haan acknowledged. “But Andrew had a very open mind when we came in, and accepted very well the fact that we have so much history together.”
A self-defined East Coast guy, Mr. Sossen said that living in New York cuts down on his ability to ride and ski. But when they are all in the same city together, the five will get together for dinner or drinks.
At work, the roles are well-defined. “I handle anything legal, capital market activity, raising capital, interacting with the Street—everything kind of M&A or strategic,” Mr. Sossen said, rattling off team members’ various strengths. “Chris is a phenomenal credit mind—all deals run through him. Warren knows everybody there is to know in the real estate business—he has a call in to every borrower. Stew is wickedly smart. He brought a quantitative approach to the business that wasn’t here prior his arrival. Boyd is a great partner and face for the organization. Warren and Boyd as a team going to meet potential borrowers is a pretty deadly combination.”
But just as important as the debt team’s relationship is its synergy with the equity team at Starwood Capital Group. “What makes the REIT truly unique is that we have excellent debt skills and excellent property-evaluation skills,” Mr. Sternlicht asserted.
The deals over $125 million have to be approved by Starwood’s board, and the investment committee consists of an equal number of equity professionals and debt professionals. “It’s a huge strategic advantage, the Starwood equity guys understand the equity risks really well in this market,” said Mr. Fellows. “We go back and forth with them getting their input on the lending, how to structure the loan and how to make sense. It’s a really powerful synergy. But that’s easy to say. At the beginning, you have to get everybody to start to trust and respect each other and work together and feel good with each other. That integration process took time. Now, the morale is great and people work together very well, and it feels like a cohesive machine.”
In one of the most recent examples, in early November 2012, Starwood Property Trust originated a $126 million first mortgage and mezzanine loan on 100 Montgomery, a 25-story building in San Francisco, which Blackstone had just bought. While the building was on the market, Marc Perrin, Starwood Capital Group’s managing director who supervises the investments on the West Coast, had visited the property, done the underwriting and come to know it intimately. “When the deal was ultimately awarded to Blackstone, we called Marc and had a discussion with him about the building,” said Mr. de Haan. “We closed the deal in 25 days.”
Mr. Sternlicht said that he often sources the transactions and then puts the deal in the hands of the debt team, with which he stays in constant contact. He added that they are currently working on large transactions in New York that could close by the end of the year.
“We have another approximately $500 million [of new investments] in due diligence now,” said Mr. Fellows. “As we have grown and become bigger, we have become able to take down large complicated transactions in which we rarely have any competition.” Compared with banks and insurance companies, which often co-originate the loans, Mr. Fellows added, Starwood Property Trust has the ability to be the only lender on large and complex deals and to make the negotiation process more simple and certain. “We’ll just say [to the borrower], ‘We’ll take the whole thing, simple, with no noise. You don’t have to talk to all these people. One contract. Done.”
“We are on everybody’s short list of lenders,” added Mr. Sossen. “We’ve proved that we can transact quickly, we can underwrite complex situations—and when we say that we are going to close, we are going to close, and I think borrowers appreciate that certainty.”
“We’ve been successful because we have been transparent with our shareholders, have laid out a clear plan as how we wanted to grow the business and haven’t deviated from that plan. And I think shareholders appreciate that transparency and predictability, which is what we have really delivered over the past three years.”
In the third quarter of 2012, net income attributable to the company jumped to approximately $50.2 million from $14.5 million for the same period in 2011. Profit per share was $0.43 compared with $0.15 in the prior year. Core earnings were $58.8 million, or $0.50 per share, up 49 percent from $39.3 million, or $0.42 per share, in the third quarter of 2011.
“We’ve all faced other opportunities from time-to-time for sure,” said Mr. de Haan. He added that the team’s uniqueness and differing skills sets make the sum total more powerful than the individual components.
“So,” he mused, “we could create something bigger, more scaled and probably more fun by working together.”