Starlight stops payouts on two funds as interest rates rise

Starlight Investments, one of Canada’s largest owners of apartment buildings and multifamily properties, is halting monthly payouts on two of its funds, another sign that higher interest rates are causing trouble across the real estate sector – even for the most sophisticated managers and investors.

Starlight, which owns $25-billion worth of properties and real estate securities in Canada and the United States, paused distributions on two funds that specialize in U.S. properties: the U.S. Residential Fund and the U.S. Multi-Family (No. 2) Core Plus Fund. Combined, the two funds have $840-million in assets under management, and both are publicly traded in Toronto after initial public offerings in 2021.

The two funds were set up to capitalize on a rebounding U.S. real estate sector. While Canada’s market has been hot for nearly the entire pandemic, American real estate took some time to turn frothy, both in terms of property values and monthly rent increases.

The Starlight portfolios benefitted from this strength, with average rents on properties in the larger U.S. Residential Fund jumping 17 per cent year-over-year in the third quarter. Yet rising interest rates are now biting because both funds rely on short-term, variable-rate mortgages to finance their purchases.

“The size and pace of interest rate increases has been unprecedented and has resulted in interest rates that are significantly higher than projected at the time the fund financed its properties,” Starlight wrote to investors Friday. In response, the company is halting distributions that paid a 4-per-cent annual yield.

Starlight’s Canadian funds are not affected, but the real estate sector here is not immune from the industry’s woes. In mid-November, Romspen, one of Canada’s largest private mortgage lenders, halted redemptions to prevent its predominantly retail investors from cashing out of its funds. The company has not said how long the freeze will last.

For Romspen, the major issue is that its private loans cannot be sold quickly, or easily, in order to fund redemption requests. For Starlight, the problem stems from its borrowing costs. Rising rates are also limiting access to loans.

“The significant increases in interest rates have also contributed to an increase in volatility across capital markets, leading banks and other debt providers to reduce their lending capacity while increasing the cost of new loans,” Starlight added.

The company did not respond to a request for comment.

Both Starlight funds were set up to buy U.S. properties that benefit from rental rate increases as tenants turn over. The funds are designed to be short-term investment vehicles, buying properties and then selling them after three years. The U.S. Residential Fund owns interests in six multifamily properties, consisting of 1,973 suites, as well as 98 singlefamily rental homes. The No. 2 U.S. Fund owns interests in three properties, consisting of 995 suites.

The short-term strategy has worked before. Starlight’s U.S. Multi-Family (No. 1) Core Plus Fund, for instance, sold its portfolio in September, 2021, and investors earned a roughly 28-per-cent return in less than two years.

But the interest-rate environment has changed dramatically in 2022, and the affected Starlight funds rely on shorter-term, variable-rate mortgages – whereas many commercial real estate owners use 10-year fixed-rate mortgages.

Starlight also used variablerate mortgages because they can be repaid with no – or minimal – cost, while fixed-rate debt has costly repayment terms if repaid before the maturity date.

Despite the current financing struggles, Starlight said it believes real estate fundamentals are still strong, with solid job and population growth in markets where it owns properties. The decision to halt payouts, then, was framed as a “prudent approach to managing the fund’s financial position and liquidity.”

However, rent growth and property values are starting to cool in many U.S. cities, and Starlight isn’t the only Canadian real estate company hit by changing dynamics in U.S. real estate. Dream Residential REIT, which also invests in multifamily properties across the U.S., went public in May, right as interest rates were starting to rise. The units have been hammered on the Toronto Stock Exchange, dropping 42 per cent.

Toronto-based Tricon Residential Inc., which also owns U.S. properties, has watched its own shares drop 38 per cent since the start of the year.