Private REITs, public scrutiny

Blackstone and Starwood stepped into a charged environment last month when they slammed the brakes on shareholders pulling cash from their high-flying real estate vehicles.

At the time, disgraced crypto guru Sam Bankman-Fried (who within days would be indicted on fraud charges) was all over the news and social media following the collapse of his FTX crypto exchange. Comparisons between FTX and the private equity giants’ non-traded REITs came easy.

“What is happening now with private REITs is more important to markets than the FTX blow up,” Phil Bak, CEO of Armada ETF Advisors, tweeted on Dec. 6.

Starwood Property Trust CEO Barry Sternlicht didn’t see it that way.

“This is not FTX,” he told a crowd at a conference hosted by New York University’s Schack Institute of Real Estate the same day.

Blackstone’s Stephen Schwarzman and Jonathan Gray expressed bewilderment at the hand-wringing over the caps on investor withdrawals. 

“The idea that there is something going wrong with this product because people are redeeming is conflating completely incorrect assumptions,” Schwarzman said. “This was not meant to be a mutual fund with daily liquidity. These are pieces of real estate.”

The Securities and Exchange Commission reportedly reached out to Blackstone and Starwood to ask how the companies are handling redemptions, but no one at either firm has been accused of the kind of fraud Bankman-Fried is alleged to have committed.

On January 4, Blackstone announced that the University of California’s pension plan pledged to invest $4 billion in BREIT. Blackstone agreed to a side deal in which it will backstop, up until a point, an 11.25 percent return for the pension plan.

One of the big questions going forward is how much demand for withdrawals is building underneath the caps, and how that will affect the platforms’ operations. If redemptions at Blackstone’s $69 billion REIT remain at the 5 percent quarterly limit for a year, that would work out to one fifth of its assets under management, or nearly $14 billion.

“That’s a lot of money for a vehicle of this size,” said Mitch Rosen, head of real estate at the investing platform Yieldstreet. “That’d be a big problem.”

All caps

Since its launch in 2016, Blackstone Real Estate Income Trust — BREIT for short — has become one of the largest growth drivers for the private equity giant.

Unlike publicly traded REITs, where investors can buy and sell shares on the open market with ease, non-traded REITs are by their nature less liquid. Blackstone and Starwood each set their REITs up with limits on how much money investors can take out: either 2 percent a month or 5 percent each quarter.

Redemptions at BREIT started to climb in the spring when Asian investors, stung by lagging property markets at home, began to pull their money out. The company pays a pro-rated slice to each investor who asks to cash out, and shareholders have to line up again each month to resubmit their requests.

At the same time, new subscriptions are slowing. Through November, Blackstone’s REIT had raised $19 billion from investors last year, down from $25 billion the year before. The company had $9.3 billion of liquidity, just shy of $8 billion of which is on its credit facilities.

A spokesperson for the company said, “Our business is built on performance, not fund flows, and performance is rock solid.”

The spokesperson declined to comment on how adverse fund flows affect performance.

The squeeze on both ends has raised at least one big flag.

In a rare downgrade for Blackstone, Credit Suisse research analyst Bill Katz in November lowered his rating on the private equity firm from neutral to underperform, citing the slowdown at BREIT and a similar retail product focused on private credit.

Others took it as an opportunity to talk their book.

Private equity firm Ares Management, which has the third-largest non-traded REIT behind Blackstone and Starwood, filed a notice with the SEC just to let the world know its investors weren’t heading for the doors.

“In light of public reports regarding the redemption limits of other NAV REITs, Ares Real Estate Income Trust Inc. announced today that it fully satisfied all stockholder redemption requests in October and November in the ordinary course and it continued to experience positive net inflows in October and November from its capital raising efforts,” the notice read.

As funds continue to flow out of REITs, their operators may have to sell properties to meet redemptions.

Blackstone’s REIT recently sold its 49.9 percent stake in the MGM Grand Las Vegas and Mandalay Bay to Vici Properties, a publicly traded, casino-focused REIT, at a valuation of $5.5 billion — a $700 million profit in three years.

The danger for Blackstone and Starwood’s REITs is that if redemption requests remain elevated, they may have to sell properties in a declining market. That could lead to lower values and cause more investors to head for the exit, creating a downward spiral.

Armada’s Bak questioned whether Blackstone’s valuations would hold up in that scenario.

“But will Blackstone be able to sell properties at those appraised prices?” he tweeted on Dec. 6. “LOL.”

How low can it go?

Another reason these private REITs have received more scrutiny lately has to do with their valuations.

Unlike their publicly traded brethren that are valued based on their share prices, non-traded REITs are valued by marking their assets to market prices. That’s resulted in a noticeable disconnect this year, as Blackstone and Starwood’s private REITs have returned more than 8 percent, compared to a roughly 20 percent decline in the MSCI US REIT Index through the end of November.

When real estate stocks fall in spite of strong property markets, the heads of publicly traded REITs are quick to say that public investors are undervaluing their companies. The executives behind the private REITs say they’ve solved this problem. Non-traded REITs may not jump as much as the publicly listed ones, but they also don’t fall as much based on investor sentiment.

The big question now is, are public real estate companies undervalued, or are the private REITs overvalued? The answer may be something in between.

Kevin Gannon of real-estate focused Stanger Investment Banking said that the redemptions next year will show whether Blackstone and Starwood’s value calculations were correct.

“I think that the level of redemptions will test the veracity of the [net asset values] in 2023,” he said.