Investors worried about what life is left in the stock market might want to listen up.

Starwood Capital Group Chairman Barry Sternlicht—who made his name hoovering up distressed assets after the Great Recession—just said there is a ‘category 5 hurricane’ heading for the economy.

And commercial real estate, he believes, is about to incur the biggest collateral damage.

“We’re in a Category 5 hurricane,” Sternlicht said in a recent interview with Bloomberg. “It’s sort of a blackout hovering over the entire industry until we get some relief or some understanding of what the Fed’s going to do over the longer term.”

Sternlicht predicts this catastrophe just as Wall Street climbs out of a bear market and counts up its gains for the year so far.

Commercial real estate collateral damage

While the 2008 housing crisis was caused by excessive risk taking, this time, commercial real estate looks to be “collateral damage” in the Fed’s fight against inflation, Sternlicht says.

Higher financing costs for landlords are being compounded by tight credit conditions—which means developers can’t refinance or start new projects. Due to falling demand, lenders are also shying away from office space.

Starwood manages some $115 billion of assets and has a bird’s eye view of what’s going on. It has also struggled to refinance its own deals and had investors withdraw from its funds.

The potential threat to financial markets here is immense. In the face of a slowing economy, an estimated $1.4 trillion in commercial real estate debt is due to be repaid by the end of 2024.

“The economy will slow. You can see the numbers. CEO confidence is down, consumer confidence is down, retail sales are down,” Sternlicht said in the interview.

“The service economy is wickedly strong. It just feels like the last gasp before we actually settle into what should be - what you’d expect to be - I hope it’s a shallow recession.”

Banks caught in the crossfire

Real estate is very often the cause of recessions, as Sternlicht explained, especially when banks lend irresponsibly. “In this case, we really were an accidental consequence of the Fed’s actions,” he said.

“We didn’t really cause this problem.”

The fallout could mean a re-run of the Savings and Loan crisis clean-up of the late 1980s and early 90s.

Back then, when Sternlicht launched his own real estate firm, the government set up the Resolution Trust Corp (RTC) to sell off assets from all the failed institutions.

This time around, a new RTC would need to absorb up to 500 failed banks, he said. “And they will have to sell. It also will be a great opportunity.”

How Sternlicht suggests playing this crisis

While commercial property has been hit by the double whammy of the recession and the rise of work from home, Sternlicht thinks the fundamentals for residential are still sound on a long-term view.

“I think real estate has a nice place in the balance sheet of any individual,” he said, adding that publicly listed Real Estate Investment Trusts (REITs) could be a clever way to play the coming crisis.

During the pandemic, Starwood scored 70% returns from a special REIT focused on undervalued assets during the pandemic. And it appears that Sternlicht is going back to that playbook once more.