Blackstone, Starwood CEOs Defend Investment Strategy Amid Surging Cash-Out Requests
Investor Shift Still Likely To Reduce Buying Power, Analysts Say
By: Mark Heschmeyer
Starwood Capital CEO Barry Sternlicht, left, and Blackstone Group CEO Stephen Schwarzman. (Getty Images)
The heads of Blackstone Group and Starwood Capital Group are defending their nontraded real estate investment trusts, which are both reporting a surge in investor cash-outs.
Stephen Schwarzman, CEO of Blackstone, spoke publicly at a Goldman Sachs investor conference this week for the first time since the firm disclosed it had to partially close the gate on honoring the requests.
Schwarzman said Blackstone Real Estate Income Trust’s holdings include property types and locations in the best-performing sectors over the past six years. That has helped boost the fund to an average return of 13% a year, he said.
With that healthy performance, Schwarzman said he was baffled when redemption requests started rising in the third quarter.
“We started asking ourselves what’s going on and we find out a fascinating thing, that these redemptions were preponderantly coming from Asia,” Schwarzman said. “It didn’t take long to figure out that [Hong Kong’s Hang Seng stock index] was down 40%. Asians tend to use more leverage, more margin debt. So, if you’re an investor who’s got margin debt and their market goes down 40%, you can imagine what it was like to be one of those individuals. You’re under excruciating financial pressure, and so they were just looking" for cash.
Industry analysts, however, think the exodus of money is likely to grow and could stifle fundraising in the coming months.
A smaller cache of money to buy property signals a dramatic change for Blackstone, one of the largest global real estate owners and an entity that has pumped up the net asset value of the fund, known as BREIT, to $70 billion in just six years. The fund has attracted industry attention for its quick rise to the top of the list of nontraded REITs, with 80% of its investments in multifamily and industrial properties, 70% of which is located in the Sun Belt.
Surpassing Quarterly Limit
The calls to redeem shares surpassed BREIT’s quarterly limit on redemptions of 5% of net asset value as wealthy private investors followed suit. The fund had to begin limiting redemptions. While it met redemption calls in the third quarter, BREIT allowed investors to withdraw only $1.3 billion in November. That represented about 43% of the redemption requests it received.
Meanwhile, Starwood Real Estate Income Trust joined BREIT in applying a cap this week, reporting it fulfilled only 63% of investor redemption requests in November.
That left many investors in both REITs unable to do so. If they want to cash out again this quarter, they have to reapply.
The moves have caused some real estate industry investors to call into question the nature of nontraded REITS, which are not required to provide investors with the same amount of transparency about their holdings as public REITs. On Twitter, Phil Bak, CEO of Armada ETF Advisors, said “what is happening now with private REITs is more important to markets” than the collapse of cryptocurrency trading firm FTX, which has been criticized for poor corporate governance.
While Bak is not alone in that sentiment, it is not a view shared by either Schwarzman or Barry Sternlicht, chairman and CEO of Starwood Capital, the sponsor of Starwood REIT.
At a New York University capital markets conference Tuesday, Sternlicht explained what's behind Starwood REIT’s recent move to limit investor redemptions.
“We don’t run a hedge fund,” Sternlicht said. “We own real property. We can’t liquidate our property overnight ... and just sell your apartments in one minute. We have to manage liquidity. It isn’t a run on the bank. This isn’t FTX. There’s a huge giant asset base behind these companies. There are properties. You can see pictures of them. There are cash flows. It’s not the end of the world. These are very sound vehicles.”
Impact on Nontraded REITs
The longer-term cost from the excessive redemption calls may come to the wider nontraded REIT sector, according to Alex Pettee, president and director of research and ETFs at Hoya Capital, in an email to CoStar News.
Blackstone launched BREIT in 2016 at a time when the nontraded REIT sector had all but dried up after a series of accounting scandals and allegations of excessive fees that had soured investors on the formerly popular option for parking their money. Capital raising plunged 20% in 2014, with about $16 billion in equity raised, and 2015 sales were down 36% year over year.
Blackstone hoped to turn this high-fee sector on its head, undercutting competitors by capping fees at less than 7% and offering wealthy private investors the opportunity to cash out monthly or quarterly.
Nontraded REITs provide updated net asset values regularly throughout the year, often either monthly or quarterly. The values are determined by appraisals of a REIT’s assets minus its liabilities and are used to set the price of outstanding shares. The structure is vastly different from public REITs, with prices that rise and fall with the larger market.
“For years, the pitch was, ‘We’re not like the other nontraded REITs.’ But we’re now seeing it’s the same game, but simply with more polished marketing materials,” Pettee told CoStar. “BREIT marketed performance to retail investors using valuations that were, quite frankly, absurdly over-inflated on the face of it given the valuations of directly comparable assets in active public markets.”
However, Pettee added, in making good on those lofty valuations and giving payouts, BREIT has shut the gates for the time being on some investors.
“It’s within their rights per disclosures to halt redemptions, but there are serious questions to be asked and answered about the valuation techniques and the frequency of updates,” Pettee said.
Headwind for Blackstone
A long run of high demand for share redemptions could prove costly to Blackstone, according to Rufus Hone, an equity analyst for BMO Capital Markets.
The redemptions will prove to be a headwind, Hone wrote in a report for clients. He lowered his medium-term growth estimates on Blackstone by 12% and the stock’s target price from $109 a share to about $90 a share.
As of midweek, Blackstone’s stock was trading at about $79 a share, down from the roughly $85 it was trading at prior to the redemption news that emerged Dec. 2.
“We expect a large backlog of redemption requests” for the first quarter of 2022, Hone wrote. “Will BREIT recover? This largely depends on whether redemption requests from existing investors drops significantly — in the near term, we think this is unlikely. Absent several large asset sales, we see redemption requests remaining stubbornly high.”
James Sprow, senior vice president research at alternative investment research firm Blue Vault Partners, agreed.
“The continuously offered nontraded REITs such as Blackstone REIT and Starwood REIT are likely to have requests for common share redemptions exceed both monthly limits" of 2% of net asset value and quarterly limits of 5% of total net asset value "for the foreseeable future as those requests get only partially fulfilled,” Sprow told CoStar in an email.
The excessive redemption requests could go on as long as there is a mismatch between the price at which shares of private nontraded REITs such as Blackstone are trading compared to what publicly offered REIT shares are trading, Sprow added.
The situation sets up what’s known as an arbitrage play, which is simply an opportunity to buy one asset at a lower price in one market than what it is selling for in another. In this case, the assets are REIT shares.
“The re-balancing argument makes sense as [publicly] listed REITs have performed poorly relative to nontraded REITs, but nontraded REITs should not be looked to" for a chance to cash out quickly, Sprow said. “The fact remains that commercial real estate is not suitable for short-term investments and individual investor portfolios that are over-allocated" to assets that can't be cashed out in a hurry, "such as commercial real estate will continue to face challenges.”
And while Blackstone and Starwood potentially face an extended call to redeem shares, they are in position to be able to withstand the storm.
“The REITs are large and well capitalized" and can "fund redemptions well into 2024 without selling assets,” Kevin Gannon, chairman and CEO of investment banking firm Robert A. Stanger & Co., told CoStar in an email.
However, Gannon added, with caps on redemptions still in force, new fundraising by the REITs is also likely to contract.
“If redemptions continue, then assets will likely be sold in the quarters before that,” he said. “I would say BREIT and SREIT are conservatively built for this type of redemption activity.”
CoStar News reporter Andria Cheng contributed to this story.