Starwood Capital Group CEO Barry Sternlicht thinks investors’ love affair with artificial intelligence is about to end in a breakup, and commercial real estate will be their shoulder to cry on.

Federal infrastructure spending and hype around artificial intelligence has artificially inflated associated sectors like chipmakers and data centers, the outspoken executive said on the earnings call for his Starwood Property Trust REIT's earnings call Tuesday.

Sternlicht, who's been calling on the Federal Reserve to cut rates for months, expressed optimism that the recent weak jobs report that spurred a stock selloff would finally push Chairman Jerome Powell to make a rate cut at the Fed's meeting next month.

“This is the emperor has no clothes,” Sternlicht said. “You've seen that this economy is super narrow, the GDP is being driven by data centers and spending on stuff that the average person doesn't feel. They don't feel like the economy is working for them.”

The AI excitement seemingly has already begun to cool, with the tech-heavy Nasdaq stock index falling into correction territory last week. Sternlicht said Tuesday he expects investors who abandoned real estate during the pandemic will come back to the asset class, particularly multifamily and hotels.

Real estate has “obviously got a different risk profile than some new chip that may or may not live forever, or get taken down and go the way of the dodo bird,” Sternlicht said on the call.

Sternlicht said the increased odds of a rate cut means the commercial real estate sector could be about to turn a corner.

“For the first time, we can see the sun and the clouds breaking apart,” he said.

The early stages of that pivot could already be playing out. Starwood Property Trust REIT, which is primarily a CRE lender, had $606M of capital returned in the second quarter, but more than $620M in capital returned in July alone, President Jeffrey DiModica said.

“You are definitely seeing a trend with more capital starting to be returned, which means they have the ability to refinance assets away from us, and that is a good part of the unfreezing of the markets,” DeModica said.

Starwood reported its adjusted debt-to-equity ratio is at its lowest level in two years and said it had $1.2B of cash and undrawn credit capacity at the end of the quarter. Investors have provided nearly $2B in fresh equity to the firm over the last year.

Starwood had $78M in second-quarter income, which factored in a $42.7M increase to the firm’s credit loss provision fund, now totaling $354M. Starwood saw repayments and sales of $994M in the second quarter, slightly off from over $1B in the first quarter.

Starwood still missed analyst expectations, reporting earnings of 48 cents per share in the second quarter, short a penny from the consensus and down from 59 cents in the first quarter.

A sentiment shift in real estate's favor has manifested in the stock market, where REITs have surged in recent weeks after treading water for the prior 18 months.

This is a critical moment, Sternlicht said, and if the Fed doesn’t act fast enough, it could “break the egg” that is the economy.

The economy is in a more fragile state than the data would suggest, Sternlicht said. The CHIPS Act, the Infrastructure Investment and Jobs Act and the Inflation Reduction Act poured federal funds into the broader economy, and more specifically, the technology sectors that were simultaneously benefiting from surging interest in AI.

Public spending and gains in those sectors are masking a broader weakness in the market, Sternlicht said.

“Private construction of multifamily is going to get cut in half, logistics are down 70%, probably the only office buildings being built in this country are for built-to-suits,” he said. “All of this private investment has now shifted to public investment.”

Even as Starwood prepares for an influx of commercial real estate investment, the firm is strategically diversifying outside of the sector, with 40% of the firm’s assets now outside its commercial lending book and in sectors like infrastructure and energy.

“As this multi-portfolio and our other non-CRE lending businesses like [special servicing] and energy infrastructure lending continue to perform well, our company moves further and further away from being just a mortgage REIT,” DiModica said.