The decision of two of the nation's largest private real estate income trusts (REITs), managed by Blackstone and Starwood, to limit and prorate investors' repurchase requests because they exceeded redemption restrictions rocked the fast-growing private REIT market, which had flourished during the low interest-rate era from 2017 and 2021.
Industry experts tied the surge in investor redemptions directly to a perceived gap between the performance of these nontraded REITs and public REITs. Given the expectation that interest rates will continue to rise, market conditions are likely to make it difficult for the private funds to perform well in the near future. Analysts said these pressures are unlikely to ease in the next few months, leaving Blackstone and Starwood—and perhaps other nontraded REITs—facing a period of uncertainty.
Blackstone Real Estate Income Trust (BREIT), with a net asset value (NAV) of about $70 billion and $125 billion in assets under management, announced the closing of redemptions for this quarter in a letter to shareholders last week that was also posted on its website. Starwood’s announcement came over the weekend, according to Barron’s, which received a copy of the letter from a shareholder. Starwood Real Estate Income Trust (SREIT) is valued at about $14.6 billion.
In 2017, Blackstone, believed to be the nation's largest owner of real estate, began marketing a new variant of private REITs, called NAV REITs by industry professionals. The new product had noticeably lower commissions and fees than prior generations of private REITs, some of which were viewed in a negative light because of high costs and poor performance.
BREIT also allowed investors to redeem 2% of their assets monthly and 5% quarterly, providing investors with more liquidity than other private real estate investment vehicles. The product, sold through brokers and advisors, proved hugely popular and Blackstone's success attracted imitators, including Starwood, Nuveen and Griffin Capital, now a subsidiary of Apollo Investments, among others.
The new vehicles also gave Blackstone and others access to smaller, high-net-worth, accredited investors who historially had lacked the resources to invest in its traditional products. This move to democratize private alternative assets is now revealing a problematic side, some think. One major reason some investors now are flocking toward the exit, sources said, is because they’re applying short-term thinking to a long-term investment.
“BREIT is in so many people’s portfolios,” said Zac Boca, founder and CEO of AltExchange, a New York-based data and technology company focused on alternative investments. “Like many other alternatives accessible through custodial platforms, they offer some redemption and liquidity. For a lot of investors, this looks like any other public investment. But it’s not.”
While public REITs are traded on the major securities exchanges, nontraded REITs are considered private investments. Redemption programs can vary. Moreover, public REITs are regulated by the SEC and must file audited financial statements, while private REITs are sold to accredited investors and have far more latitude in determining their short-term prices.
In the case of BREIT and SREIT in 2022, both funds held their value while public REITs with similar portfolio assets are down around 30%, sources said. According to their websites, SREIT’s 2022 return through October was 10.2%, and BREIT’s was about 8.5% over the same time period.
For much of 2022, these so-called NAV REITs were still posting increases in net asset value, while publicly traded REITs were declining sharply along with the stock and bond market, sources said. This has made redemptions attractive to investors seeking to raise cash without recognizing capital losses. Some reports said BREIT received significant redemption requests from Asian investors in recent months.
“NAV REITs raised a substantial amount of capital, showed some good NAV growth while the Fed was raising rates and traded REITs were declining,” said Kevin Gannon, chairman and CEO of Robert A. Stanger & Co in Shrewsbury, N.J. “The NAV REIT investors and financial advisors responded by slowing the rate of fundraising and increasing the rate of redemptions. It is likely that there will be some decline in [all] NAV REITs to be recorded in the near term.”
Gannon noted that Blackstone's ability to meet $3 billion in redemptions was impressive and said that those NAV REITs focused on multi-family housing and logistics facilities had enjoyed strong performance in recent years. However, he wasn't surprised investors were now looking elsewhere. "Right now, CDs, traded REITs and BDCs relying on variable rate investments may be more appealing," he said.
"It's great that BREIT could meet that $3 billion demand," agreed Meghan Pinchuk, CIO at Morton Wealth in Calabasas, Calif. "But now this means they don't have that cash to make investments as prices come down in real estate."
It's not surprising then that Blackstone appears to be trying to shore up BREIT's internal liquidity. Bloomberg recently reported that Blackstone CEO Jon Gray personally invested $100 million in the fund. And last week, BREIT sold its 49.9% interest in MGM Grand and the Mandalay Bay in Las Vegas for $1.27 billion, according to Reuters.
Private REIT Structures
The Blackstone letter that appeared on BREIT’s website explaining the closing of repurchases was just three paragraphs long, beginning with a summary of the way the repurchase plan worked. It allowed for repurchases of up to 2% of NAV in any single month and up to 5% of NAV in any single quarter. SREIT’s repurchasing limits are the same.
“This structure was designed both to prevent a liquidity mismatch and maximize long-term shareholder value,” the BREIT letter stated.
Back in October, the repurchase requests were 2.7% of NAV, or about $1.8 billion, the letter said, and the board of directors agreed to fulfill 100% of those requests. But then in November, repurchase requests again exceeded 2% of NAV and between those two months the 5% allotment for the fourth quarter was also exceeded, the letter said.
“Accordingly, BREIT repurchased approximately $1.3 billion in November, equal to its 2% or NAV monthly limit and approximately 43% of each investor’s repurchase request,” the letter said. “In December, up to 0.3% of NAV will be eligible for repurchase to total 5% of NAV for the quarter. If BREIT receives elevated repurchase requests in the first quarter of 2023, BREIT intends to fulfill repurchases at the 2% of NAV monthly limit, subject to the 5% of NAV quarterly limit.”
According to Barron’s, SREIT hit its November limit when investors tried to redeem 3.2% of NAV. SREIT fulfilled 63% of those requests.
In some ways, these nontraded REITs seem to be victims of their own success. BREIT is open to investors with $25,000 in investible assets and required a low minimum investment of $2,500. SREIT offered some share classes for investors with a net worth of at least $70,000 and gross annual income of at least $70,000, with a minimum investment of $5,000.
“The teachable moment here is around this kind of structure,” Pinchuk said, adding that she avoids investments that have all the hallmarks of liquidity and yet don’t have a regular valuation mechanism that would support that.
Some are also questioning whether the brokers and advisors who sold these NAV REITs provided investors with sufficient education. “Historically, you had to be a more sophisticated investor, or be associated with a more sophisticated advisor, to access alternatives. But because the Blackstones made it easier to get into, there are a lot of people in the fund who, guaranteed, do not understand it,” she said.
The suspension of repurchases is absolutely the right thing for these funds to do, Pinchuk continued, to protect the investors who intend to stay. “It keeps the price from tanking so they won’t be left holding a bad asset,” she said. “There will be some unhappy investors, but they’re the ones not properly educated by their advisors. This is why the gate is there. It’s not appropriate for BREIT to let out more than the structure can handle.”
Illiquid gold?
The lesson, financial professionals said, is that investors need to understand liquidity, or in this case illiquidity.
“When money is coming in and growing, none of this is an issue. And people have been really happy with it so far, because the managers are not pricing it, they’re not writing stuff down,” Pinchuk said. “It’s great that we’ve democratized this and given investors access, but the odds are they don’t understand it.”
Jeffrey Nauta, a principal at Hendrickson Nauta Wealth Advisors in Belmont, Mich., invests in a real estate fund that's similar to BREIT. "Frankly, I'm surprised that advisors and the market are spooked by BREIT," he said. Other REIT funds have "gated redemptions over the years," he said. "Investors should approach these types of investments as long-term holds."
If there's a lesson for advisors and investors from BREIT's closing off redemptions, he added, it's that "these investments should be considered illiquid."
Edward Fernandez, president and CEO of 1031 Crowdfunding, a real estate investing platform based in Irvine, Calif., said that real estate investments are a core, long-term investment. “If you want short-term gains, invest in the stock market and options,” he said.
Real estate is a good investment in an inflationary environment, Fernandez explained, but it is cyclical. “We’re in a situation today where the good times are coming to an end, [and] everyone’s been spoiled,” he said.
Michelle Connell, president of Dallas-based Portia Capital Management, concurred. “I don't know that this news is a new revelation regarding the ownership of alternative assets,” she said. “I think it's just another example of why investors and advisors have to understand the potential risks of alternative investments.”
These sorts of assets “require much more due diligence than those traded in the public markets,” she added. “Alternative asset investors need to understand the potential illiquidity issues of what they are buying.”
But most importantly, investors need to understand that gating redemptions when a certain threshold is reached doesn’t necessarily mean BREIT is or was a bad investment. “For REITs that invest in illiquid assets, like real estate, this is a necessary precaution that seeks to balance investor expectations and needs with those of running a real-estate investment platform,” said Ken Stern, president of Los Angeles-based Lido Advisors.
Gating withdrawals has no direct bearing on the merits of the investment one way or the other, he said, adding that Blackstone is a “well-respected asset manager with a good team at the helm. ”Still, when considering investing in BREIT, or any other investment, clients should understand “the asset class, its place within your portfolio, and whether that investment achieves your objectives,” Stern said.
Alternative assets remain a legitimate allocation for investors, as many of them can help preserve value during challenging periods, Pinchuk said.
“BREIT was the training wheels for a lot of investors and RIAs to get their feet wet in alts. Many will graduate to other types of alternatives that are less liquid,” Boca added. “In a highly recessionary environment, real estate is not a bad place to be.”