Alternative assets have generated their share of concerns in the last two years but the industry seems to be addressing many issues and is emerging with little long-term damage. Areas like Business Development Companies (BDCs), so-called non-traded NAV REITs, private placements and interval funds are projected to record about $100 billion in sales in 2024, up from $75 billion last year, according to Robert A. Stanger & Co. CEO Kevin Gannon..
The traditional alternatives market for advisor-sold investments is seeing some noticeable structural shifts, with BDCs benefiting at the expense of non-traded REITs at least in the short term. BDCs are expected to raise a whopping $25 billion this year, Gannon said. That would be a double-digit increase from the $21.15 billion they brought in last year, according to Stanger.
The reason is simple. BDCs offer investors yields of 8% to 10%, while most non-traded REITs provide payouts of only 4.5% to 5.5%. That latter figure is similar to what CD’s are now offering, Gannon says.
Yields approaching 10% exceed those of many junk bonds. They may be popular with income-seeking investors but clients who are risk-averse or are reaching for yield because they didn't save enough for retirement should be forewarned. If BDCs experience cash flow problems, those juicy payouts could get trimmed.
Some non-traded REITs continue to see big redemptions in products issued by major sponsors, like Blackstone’s BREIT and Starwood’s SREIT, two vehicles that dominated the alternatives market for several years. Sales of non-traded REITs fell dramatically from $34.43 billion in 2021 and $33.25 billion in 2022 to $10.22 billion in 2023.
Gannon predicts non-traded REITs will raise only about $5 billion this year but see redemptions of $15 billion. Yet if the redemption process continues to play out smoothly, the liquidity could legitimize the asset class.
What happened? Starting in early 2022, it became clear a big chunk of the American work force was recalcitrant when it came to returning to the office. Concern about commercial office space mushroomed and investors saw serious price declines in publicly traded REITs, particularly any REIT with office holdings. At the same time, the Federal Reserve began raising interest rates, creating competition for all sorts of income-oriented investments.
Vanguard’s giant REIT index fund (VNQ) fell 26.24% in 2022. Blackstone, Starwood and other non-traded REIT issuers did not lower the valuations on their assets nearly enought to match the price decline in publicly traded REITs. Non-traded REIT investors concluded they “wanted their money back because the price seems high,” according to Gannon.
“Publicly traded REITs tend to overvalue and undervalue different [assets] depending on the winds of the market,” Gannon says. Private vehicles, on the other hand, depend on third-party valuations, and often react in a more measured manner. When price discovery becomes challenging in the face of mounting uncertainty, like commercial office real estate in the post-pandemic world, confusion in both public and private markets can leave even the experts in a state of befuddlement. Transactions tend to dry up, so establishing fair value becomes something of a guessing game.
Blackstone, which launched BREIT in 2017, may also have been a victim of its own success though it's not exactly suffering. The timing of their debut was propitious and they caught the wave for real estate which began to take off after years in the doldrums following the Great Recession. BREIT asset approached nearly $90 billion and it attracted dozens of imitators.
Blackstone president Jon Gray has stated that many of the redemptions starting in 2022 came out of Asia. Others have suspected some brokers may have glossed over details in the product’s redemption policy. In its February 5, 2024 letter to shareholders, Blackstone noted that its “all-weather, semi-liquid strategy” had returned 11% annually to shareholders since inception, or two times that of publicly traded REITs.
For people who had invested in earlier generations of private REITs and limited partnerships, the ability to redeem their investment at 2% a month, 5% a quarter and 20% a year marked a sea change. In the past, they always had to hold the investment until “the sponsor sold the property,” Gannon says.
Blackstone also benefited from its leadership position. The private equity firm owns more than 1% of all the real estate in America, having bought up wide swaths of properties after the global financial crisis. This gives it a wealth of information about different markets and asset classes within real estate, as well as a network of buyers and sellers. When they experienced a run on the bank, Gannon notes they were able to “honor their commitment.”
Part of the reason they could handle the redemptions was that they maintained “20% of their assets in a liquidity sleeve.” Still, Gannon estimates it could be another year before BREIT’s inflows exceed their redemptions once again.
For advisors, the current management teams running these real estate investments seem more professional and less flamboyant. The earlier generation of private real estate sponsors were primarily capital raisers and syndicators like Wells Capital and Nick Schorsch’s American Realty. The current generation of sponsors includes names like JP Morgan, Invesco, PGIM, Bain, Nomura, Morgan Stanley and Nuveen, many of which have decades of experience in real estate finance.
Gannon says another development revealing the space’s increasing legitimacy is the recent decision of Cohen & Steers, a big player in the public REIT space and once a major critic of private REITs, to launch its own non-traded REIT.