Barry Sternlicht of Starwood Capital has a long history of real estate success. Nearly two decades ago, he built Starwood Hotels(HOT) from scratch into one of the world’s largest hotel companies. More recently, as Chairman and CEO of Starwood Propert Trust(STWD) he has assembled the country’s largest commercial mortgage REIT. The firm has financed some of the most complicated real estate deals in the United States.

Of interest to us is the companies recent foray into ownership of residential, single-family properties. In its earning conference call yesterday, Sternlicht described the business, mentioning that it might get spun off.

I want to spend a minute talking about our residential foray. As you probably didn’t notice but we started to buy single-family homes in the REIT exclusively. We’re not doing this in our fund. We just did this in the REIT — we don’t know how you can do this in multiple vehicles — probably the middle of last year and now we’re up to nearly 4,000 homes, about 3,665 homes. This business, which now employs — deploys about $450 million is dilutive to the company at the moment. It produces — actually loses money in the quarter, and that’s because we have chosen to enter the business by doing both NPL acquisitions as well as REO acquisitions and it’s upfront costs while the homes are being renovated to and then they’re rented. So there’s $450 million of capital not earning — actually losing money in the quarter embedded in our numbers. What’s really interesting about this as you consider our fair market book — our market to fair market book, which is between $21.50 and $22 a share, again excluding the kickers in the Canadian stores [ph] alone or the 7017s and excluding what is — kind of interesting — our average price for these homes at the time of acquisition was around 80% of the broker’s opinion of value. And what you’re seeing in these auctions today in the resi space is guys paying 105% of broker’s opinion of value — they’re legging into the trade, if you will, and we chose to enter the business in a slightly different way. And if you take that 80% on $454 million and you said that maybe it was worth par, that’s a $90 million gain to the REIT. That’s not in our numbers and not in our book value. If you actually said that the markets of single-family home markets, which they are, have rallied quite hard, which they have, and since we required some of these assets, and you’re up another 10% let’s say. I think last quarter there was an announcement or earlier this week or this month, 9% year-over-year gains in single-family homes — obviously, stronger in some markets than other markets, the Northeast being weak — we don’t own broad share, but Florida being strong, we own a lot in Florida and a lot in some of these rallying markets. That’s a 10% gain, it will be another $45 million gain, it’s $135 million of nearly $1 a share in fair value to the company and we are anticipating thinking about spinning this business out. We’ve told you about that now multiple times, and we’re — expect that, that will happen in the coming months as we move to do that. We think it’s a different business, it should have its own life. It doesn’t really belong here long-term. We’ll have different payout ratios and different implications for our current yield versus appreciation. Obviously, loans don’t really appreciate unless they’re locked out for 1 billion years and the interest rates continue to hold steady because actually, they probably have appreciated given where rates are at the moment. But we’re going to earn a pretty good cash yield. The book is completely unlevered at the moment, though we are completing a financing line right now for the resi with one of the major banks, which will be accretive to the company as well and the future company that may get spun out of us.

Later, in response to an analyst question, Sternlicht elaborated slightly on the spinoff

Joel Jerome Houck – Wells Fargo Securities, LLC, Research Division Question I guess is around just the single-family business. Obviously, it’s ramping up, it’s new. What do you think rough terms of size of this would have to be before you guys would consider spinning it out? Barry S. Sternlicht – Chairman, Chief Executive Officer and Chairman of Investment Committee We’re big enough. We’re big enough now. I mean, we can spin it out now. So we’re working through the mechanics of that and obviously are making sure our management team’s in place. And it’s interesting, there will be probably, who knows, half a dozen of these, I guess. And it will be — they’re interesting vehicles because you can always liquidate them, right? You can always sell the houses or you’re going to hold on to them and it’s really — nobody really knows. I mean you can’t — nobody has had enough operating history to know how this is going to work. Because it’s pretty competitive space, I’m not going to go into details about it. But we’ve tried to be very picky about what we’re doing and how we’re doing it and through how we’re acquiring these houses. As you may know, as you saw Colony’s earnings yesterday and there’s a lot of transaction costs up front. So you got to find — showing up at auctions where all the investors are driving prices is a really difficult way to do this. And I think as houses approach replacement cost, it gets far less interesting to acquire them. But right now, it certainly can achieve, I think, the kinds of returns we’ve seen in the debt book. Between current yield and appreciation, I think it’s safe to assume that you can see leverage yields, levered IRRs north of 12%. We should feel again asymmetric, more upside than downside.

As Mr. Sternlicht points out, this is a competitive space now with many firms coming to market. It seems clear that the company’s preferred plan is to spin, though the timing is uncertain. With Mr. Sternlicht’s track record, this is a name to watch in a space that is heating up.

Disclosure: The author holds no position in any stock mentioned

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