By Peter Grant

One of Starwood Capital Group's largest real-estate funds was overwhelmed with redemption requests last spring when a long line of investors tried to exit at the same time.

Rather than sell some of the fund's commercial property into a poor market to meet those requests, Starwood chief executive Barry Sternlicht decided to impose strict limits on the amount of money investors could withdraw.

Now, a little more than a year later, investors are still queuing up to yank about $850 million from the fund, according to Robert A. Stanger & Co., an investment banking firm that tracks the business.

The future is cloudy for the Starwood Real Estate Income Trust, known as Sreit. It has struggled to raise new money partly because it imposed what is now the tightest redemption limit in the industry.

Sreit's net asset value is now $8.8 billion, down 40% from its peak in 2022. The drop reflected declining real-estate values and investors pulling their money out between 2022 and the first quarter of 2024, before the stricter limitations went into effect.

The choice to limit redemptions was a difficult one, Sternlicht said.

The alternative would likely have been to sell properties at discount prices. Such a move would have hurt all fund investors, not just the ones trying to redeem shares, Sternlicht said.

"We're not going to have fire sales," he said.

Still, he has been unloading properties to work down the pile of redemption requests. Sreit sold $1.6 billion worth of property from December to May, according to a letter Sreit sent stockholders Monday.

The fund recently sold a shopping center in West Palm Beach, Fla., for about $133 million, slightly above what the fund bought it for three years ago, say people familiar with the matter.

The sales enabled Sreit to slightly increase the amount investors can withdraw from the fund, according to Monday's letter.

Sreit is one of the largest of the so-called nontraded REITs. Such funds are geared toward smaller investors, rather than the large pension funds, endowments and other institutions that typically invest in commercial real estate.

With a minimum investment starting around $2,500, nontraded REITs are open to anyone who has that minimum. They invest in commercial property similarly to publicly traded real-estate investment trusts, but they aren't traded on stock exchanges.

Commercial real estate with a net asset value of $81 billion is held by nontraded REITs, a sector that includes large investment vehicles from Blackstone and KKR.

The number has been dwindling after years of steady growth. The funds raised $1.2 billion while investors redeemed $2.8 billion in the first quarter, according to Stanger. In the first half of 2022, these funds raised more than $3 billion a month.

Much of the decline has to do with the high interest-rate environment that has made bonds and other investments more attractive to the small investors who were attracted to the real-estate funds.

But Starwood all but closing the withdrawal window is also rippling through the industry and causing investors in similar funds to hesitate about putting up new money, said Kevin Gannon, Stanger's chief executive.

"It's a question that everybody gets," said. "Are you going to gate like Starwood?"

The plight of Starwood investors has taken on a bigger relevance as momentum builds in Washington to ease restrictions on small investors putting money in private equity, venture capital and hedge funds.

Advocates say such a policy would offer individuals more investment opportunities. Opponents say these investors could be blindsided if these private funds restrict redemptions in bad markets.

Nontraded REITs publicly disclose that the funds have a right to close the redemption gate. But the financial advisers who sell the funds typically market them as being highly liquid compared with earlier generations of real-estate funds, say industry participants.

Sreit's troubles started in 2022, when the Federal Reserve began to raise interest rates sharply. Commercial property values fell hard, and investors got rattled. Sternlicht said he believed that the Fed would reduce rates much faster than has been the case.

Other funds in the sector took steps to increase their cash reserves. Blackstone, the sponsor of the largest of the funds, was able to lift its 15-month redemption limit early last year by raising capital through asset sales and a $4 billion investment by the University of California.

Starwood didn't take such precautionary measures. A year ago, Sreit's liquidity -- consisting of cash, marketable securities and a bank line of credit -- fell under $800 million. The fund was at risk of running out of cash, if redemptions continued at the same pace.

After Sreit drew down nearly all of its $1.55 billion credit line, Sternlicht decided to close the gate almost completely. Investors could withdraw only 1% of the fund's net asset value per quarter.

Sreit said this spring that its chief executive would be stepping down in July to pursue another career opportunity. Nora Creedon, an executive at Goldman Sachs' private real estate group, is the new CEO.

When the Fed started cutting rates last fall, Sreit started improving its capital position by selling property. Its liquidity has increased to over $900 million, enabling it to increase its withdrawal limit to 1.5%, according to Monday's shareholder letter.

Sternlicht predicts that Sreit's fundraising will come back when interest rates decline and commercial real-estate values rise. He pointed out that most of the fund's properties are apartment buildings that will soon be able to boost rents because new supply is dwindling.

"We look forward to growing once again," he said.

Write to Peter Grant at peter.grant@wsj.com

(END) Dow Jones Newswires

June 10, 2025 05:30 ET (09:30 GMT)

Copyright (c) 2025 Dow Jones & Company, Inc.