Earlier this month, investors in the Blackstone fund BREIT (Blackstone Real Estate Income Trust) learned that limits were being put on how much money they could pull out of the fund. Blackstone executives put the brakes on withdrawals after redemptions exceeded the fund’s quarterly limits. The move understandably made big news in the real estate industry. Launched just five years ago, the non-traded private REIT has grown to be one of the largest in the world at $69 billion, owning real estate assets in several sectors, the majority of which are multifamily properties. It has grown rapidly every year since its inception and has become massively popular with investors. Seeing so many investors of such a popular investment vehicle running for the exit set off alarm bells for many people in the industry and signaled to many that more pain would be ahead for the commercial real estate market.
Hitting the limit
Blackstone’s BREIT is available to wealthy investors through certain financial advisors. Those looking to invest must put a minimum of $2,500 into the fund as well as meet certain income and net worth requirements. The fund has a three-year annualized return rate of 15.5 percent and a distribution rate of 4.4 percent, according to Blackstone. At the beginning of December, Blackstone said the fund had hit its quarterly redemption limit because of a doubling in redemption requests for November, while subscriptions saw a substantial drop-off to less than $500 million, down from $880 million in September, according to Barclays. Current limits for the fund are 2 percent of net asset value (NAV) monthly or 5 percent quarterly. When this happens, the fund can limit withdrawals in order to avoid potential consequences like liquidating real estate holdings.
Most withdrawal requests came from investors based in Asia, who reportedly withdrew eight times as much money as U.S.-based ones. Foreign investors make up about 20 percent of BREIT but accounted for about 70 percent of withdrawals in 2022. Barclays downgraded Blackstone a day after news about the redemption limits, downgrading its recommendations for the company from overweight to equal weight and lowering its price target from $98 to $90. An analyst said the bank is still bullish on Blackstone in the long-term but sees short-term challenges for the firm, including a potential hit to its reputation. “It remains to be seen to what extent the limitation on withdrawals becomes a reputation problem for the company,” said Benjamin Budish.
With overall economic weakness and continued interest rate increases, the higher cost of debt has led Blackstone to readjust valuations on some of its BREIT holdings, which has had an impact on fund returns. From the start of the year through October, a large share class of the fund delivered net returns of 9.3 percent, a drop from the 13.3 percent one-year returns. Meanwhile, Blackstone is standing firmly behind BREIT’s performance numbers. “Our business is built on performance, not fund flows, and our performance is rock solid,” a Blackstone spokesperson said. But the fund’s makeup does have some potential for concern from investors. A majority of the fund is in the multifamily sector—around 55 percent—and that’s an industry that has seen a recent slowdown in rent growth.
BREIT’s portfolio is concentrated in markets in the South and West regions, with a lot of its multifamily assets in Sunbelt markets in particular. While one of the top-performing regions over the last few years, the Sunbelt experienced some of the largest declines in rent growth in the third quarter of this year. After another interest hike yesterday, BREIT probably won’t look to purchase multifamily properties at the same aggressive pace as it had been at the last two years. The second largest share of the fund, 23 percent, is invested in industrial properties. That segment has been one of the hottest performers over the last three years, much of it owed to the continued strength of e-commerce. Demand for industrial space is expected to continue for some time, according to a recent forecast by JP Morgan, with the only potential challenge being industrial’s tendency towards longer leases, which typically only adjusts for 2 to 3 percent inflation.
Blackstone makes money from the fund in two important ways, one of which is through an annual management fee based on its assets under management of 1.25 percent. The other is a 12.5 percent performance fee based on its annual total return, which is subject to a 5 percent yearly hurdle and a high water mark. With each redemption, the management fee Blackstone collects is lowered, and if the fund’s performance goes down, so do performance fees. Notable in BREIT’s guidance is that distributions can be funded from sources other than cash flow from operations, which includes the sale of assets and repayments of real estate debt investments, and there are no limits on the amounts it can fund from the sources.
In a separate announcement at the time of the redemption news, Blackstone said it was selling off its stake in two Las Vegas hotels that would free up cash for BREIT, reportedly around $730 million in profit to shareholders of BREIT. The fund has generated billions of dollars for Blackstone, accounting alone for nearly a fifth of the company’s overall fee revenues, according to Goldman Sachs. The investment bank has forecasted that the figure could reach $2.3 billion and 23 percent of Blackstone’s fee revenue by the end of next year.
Blackstone isn’t the only major real estate player feeling the sting of weakening market conditions. Just a few days after Blackstone informed investors of BREIT about withdrawal limitations, Starwood Capital curbed redemptions from its non-traded REIT, Starwood Real Estate Income Trust, or SREIT. The $14.6 billion REIT, chaired by Starwood Capital CEO Barry Sternlicht, is the second largest non-traded REIT behind BREIT. Like BREIT, Starwood’s fund allows for monthly withdrawals of 2 percent of net asset value (NAV) and 5 percent of NAV quarterly.
For Blackstone, BREIT had helped solidify its brand, something the company began to focus on in 2021 when it hired an ad executive to serve as its new head of brand strategy and transformation. Even as it is one of the largest funds in the world and the largest real estate portfolio in the U.S., it represents just 7 percent of Blackstone’s assets under management. The fund’s meteoric rise is a point of pride for Blackstone executives. In the company’s second-quarter earnings call this year, CEO Steve Schwarzman boasted that one investor even approached him on the street to sing BREIT’s praises. “I was someplace on Sunday and somebody walked up to me, and he said, ‘I’m a BREIT investor. In fact, it’s the biggest thing in my portfolio and I love you people. This is so amazing. All of my friends are losing a fortune in the market and I’m making money,” said Schwarzman.
The fund has a lot of significance in the industry, as some analysts consider the fund changed the financial industry’s perception of non-traded REITs. Ten years ago, the Financial Industry Regulatory Authority cautioned investors about non-traded REITs and later fined a number of brokers for mis-selling infractions. “This marketplace was basically perceived as a backwater of the asset management industry, and they really set out to turn it around and bring institutional-grade capabilities in real estate with a much more conducive, aligned fee structure,” said Morgan Stanley analyst Michael Cyprys. The fund has recorded explosive growth over the past four years, with its NAV soaring from $5 billion in 2018 to $63 billion in the first quarter of 2022.
In a CNBC interview, a week after the BREIT redemption limits news broke, Blackstone President & COO Jonathan Gray attempted to ease industry and investor worries. Gray said the move did not surprise investors, who knew that BREIT had limits on redemptions. “We described it as semi-liquid because we knew at some point there would be a period of volatility, and we didn’t want to sell assets at the wrong time under pressure,” Gray said. Both Gray and Schwarzman have reportedly put $100 million more of their own money into BREIT since July. The company’s unwavering confidence in the fund in interviews and statements immediately following the news seemed to have helped keep the faith—Blackstone shares rose about 2 percent after Gray’s interview.
It’s unlikely that the redemption limits will negatively impact Blackstone’s powerful brand in the long term, especially given that BREIT’s returns are still outperforming the S&P 500 Index. The fund’s main investments are in multifamily and industrial sectors, which have had shakiness lately but are widely expected to perform well going forward. BREIT is further strengthened by the ability to sell off assets within Blackstone’s sizable portfolio to free up cash for the fund, something it has seemingly already done. However, the fund pulling back is another indicator of a slowing real estate market and painful days ahead for the sector.