Redemptions curbed from non-traded REITs

What happens when alternative asset managers chase retail money as well as their traditional institutional clients — then face a down market?

Blackstone Real Estate Income Trust, and other non-public REITs, offer a cautionary tale of how money managers can take a hit when their retail investors try to redeem en masse when times get tough.

The major non-traded real estate investment trust players — Starwood Capital Group, KKR & Co. and Blackstone Inc. — have curbed redemptions from their funds as market volatility increased last year, according to SEC filings by all three non-traded REITs.

That means only a percentage of an investor's money can be returned. All three alternative money managers said in SEC filings that in general they do not satisfy all redemption requests when they exceed the vehicle's policy limits or would place an undue burden on the vehicle's liquidity or operations.

Industry experts such as Kevin Gannon expect those gates to remain in place through the third quarter of 2023 and possibly the remainder of the year.

Mr. Gannon is the Shrewsbury, N.J.-based chief executive officer of Robert A. Stanger & Co. Inc., an investment bank and property funding advisory firm that tracks non-traded REITs.

It was a rude awakening for the mostly high-net-worth investors in non-traded REITs who are used to more liquid vehicles. It's also a letdown for alternative investment managers that have been building businesses serving retail investors, which managers need more than ever as fundraising from their traditional institutional clients has dropped.

For example, in November and December, Blackstone's $70 billion Blackstone Real Estate Income Trust, known as BREIT, said in a March 28 SEC filing that redemption requests exceeded its monthly 2% of net asset value and quarterly 5% of NAV limits. This resulted in BREIT fulfilling 43% of requests in November and 4% of requested repurchases in December. BREIT fulfilled 15% of requested repurchases in March, a Blackstone investor letter said.

In response to Pensions & Investments, Blackstone said: "BREIT is not a mutual fund and has never gated. It is a semi-liquid product and is working exactly as planned. In fact, BREIT has paid out nearly $5 billion to redeeming shareholders since November 30th when proration began," the firm said.

"Strong performance is what matters and BREIT has delivered: 12.3% annualized net return since inception."

"As we have stated numerous times before, BREIT's valuation multiples have been adjusted to reflect the higher rate environment," Blackstone said. "In fact, we have sold more than $6 billion of property since 2022 at a premium to our carrying values."

While industry sources said that some non-traded REITs, including BREIT, have had institutional investors in the past, one investor took advantage of the need for cash to meet redemptions.

In January, University of California Board of Regents, Oakland, invested $4 billion in BREIT shares. However, that capital came with a six-year lockup before the university can redeem, as well as a guaranteed 11.25% annualized net return backed by up to $1 billion of Blackstone's BREIT shares, putting UC in a very different position than BREIT's mostly high-net-worth investors.

With fundraising on the institutional side slowing, portfolio managers are reserving more room in institutional commingled funds for retail money — and not just in specialized funds like private real estate investment trusts, consultants said.

"In this fundraising environment where it's been challenging for managers to raise capital from investors affected by the denominator effect, they (managers) are focusing on raising capital from" more untapped groups such as sovereign wealth funds and high-net-worth individuals, said Ethan Samson, Portland-based managing principal, private markets consultant and chairman of the individual investment solutions practice group at Meketa Investment Group.

So far, the largest brand-name alternative firms have had the most luck attracting capital from sovereign wealth fund and retail investors, Mr. Samson said.

Indeed, on April 11, Blackstone closed the largest ever real estate fund, according to PitchBook Data, its $30.4 billion Blackstone Real Estate Partners X. Institutional investors in the new opportunistic real estate fund include the $306 billion California State Teachers' Retirement System, West Sacramento; and the $143.3 billion State of Wisconsin Investment Board, Madison.

According to SEC filings, the fund has at least one sleeve or feeder fund dedicated to iCapital Network, a financial technology platform for high-net-worth and retail investors in which Blackstone has been an investor since 2018. Jeffrey Kauth, a Blackstone spokesman, declined to provide information on what percentage of the fund's total commitments are from retail investors.

The main sticking point for retail investors and their advisers is their preference for liquidity and their recent experiences with non-traded REITs could stall momentum when it comes to sales into the retail channel, industry sources said.

"The big open question that these ... groups are trying to prove out is liquidity," Mr. Samson said. "Will retail investors be OK with very little liquidity from their private capital investments for a long period of time?"

Meanwhile, a small secondary market for these gated REITs has sprung up. Stanger & Co.'s Mr. Gannon hasn't seen many transactions on the secondary market yet but expects non-traded REITs likely would sell at a discount to net asset value.

The FTSE Nareit All Equity REITs index lost 24.9% in 2022.

"It's a great test period. We'll see more NAV marks go down" in price during the year, Mr. Gannon said.

According to an April 3 Blackstone investor letter, BREIT had a net return of 8.4% in 2022.

Retail investors are paying higher fees and costs to invest in non-traded REITs, which are a type of open-end fund, than institutions are in institutional open-end funds, said Sheldon Chang, New York-based president of CrowdStreet Advisors LLC, a firm that creates pools of retail capital to invest directly in properties.

BREIT typically charges a 1.25% management fee and a 12.5% performance fee, compared with a 1% or less management fee for an institutional core-plus open-end real estate fund, Mr. Chang said. Many institutional open-end core-plus real estate funds do not charge performance fees and, if they do, they don't charge as much as 12.5%, he said.

This isn't the first time alternative investment managers chased the retail sector for money in a difficult fundraising environment, he said.

During the 2008 financial crisis when institutions were also challenged by the denominator effect — when their publicly-traded assets fell pushing up private market portfolios at or above their allocation targets — alternative investment managers turned to retail investors, propelling the development of retail investor feeder funds for institutional commingled funds, he said.

Some family office and retail advisers aren't happy and said Blackstone is marketing a gated fund.

"Advertising an illiquid, gated vehicle is terrible," said Kenneth Goodreau, an adviser to wealthy families who previously worked as the chief investment officer of the $10.3 billion Rhode Island State Investment Commission, Providence.

His gripe: Blackstone and other firms are gating funds and at the same time marketing those same funds in a potential real estate crisis. "Within the next nine months, BREIT could be serially gated," he said, adding "although I hope I am wrong."

Mr. Goodreau, who co-founded the Providence, R.I.-based Canton Hathaway family office, wants regulators such as the Securities and Exchange Commission and Financial Industry Regulatory Authority to ask hard questions of Blackstone, which itself is publicly traded.

The marketing material he said he received this month from Blackstone that P&I reviewed advertises a 4.5% annualized distribution rate and 14.7% annualized three-year rate of return.

Those rates of return are a stretch "and heap it on top of valuations that are totally void of liquid market comps," he added in an email.

"This on top of leverage will magnify returns, and on the flip side will magnify losses if anyone ever forces their portfolio to meet the realities of the market," he said. Normally redemptions would force a sale and a market clearing event that would produce a loss.

"Devoid of that mechanism they can extend and pretend forever," Mr. Goodreau added. "Common sense does not allow this circle to be squared."

Some institutional managers believe that winter is coming for investors in non-traded REITs and other private real estate funds.

Many investors believe, "as we do, that there has been a meaningful overcorrection in the public REIT market at the same time substantial markdowns in non-traded REITs and (other) open-ended private funds are fast approaching," said Todd Briddell, CEO and CIO of $13 billion real estate manager CenterSquare Investment Management, based in Plymouth Meeting, Pa., outside of Philadelphia.

His view is that asset owners and portfolio managers are in danger of making consecutive mistakes: first, not selling real estate over the past few years during the price peak, and second, not buying extremely cheap REITs today.

David Bailin, chief investment officer and global head of investments at Citi Global Wealth, New York, agrees that public REITs hold pockets of opportunity, as some are oversold. They are also more transparent than non-traded REITs.

"The risk right now in all REITs is risk of refinancing" properties already in the portfolio when their debt comes due because interest rates are higher and loan-to-value is lower, potentially requiring the REIT to add equity, Mr. Bailin said.