Blackstone’s Real Estate Co-Head Reveals How It Will Spend New $30B Fund

Blackstone has just raised the biggest real estate fund in history. But amid the most volatile market in a generation, the big question is just how and when the world's largest alternative asset manager will spend $30B of equity.

Blackstone Global co-Head of Real Estate Kathleen McCarthy told Bisnow where the new fund will be putting its money, and even more interestingly, where it won’t be following the final close of Blackstone Real Estate Partners X — the largest fund ever raised, not only in real estate but in private equity writ large. 

She also explained why the current volatility is different to the post-Lehman crisis, but will still offer up great deals, outlining how the company will structure its giant portfolio to avoid becoming prey rather than predator when the market does turn.

“We made a huge pivot in our business,” away from U.S. traditional office assets, toward industrial, rental housing, data centres and life sciences, with hotels holding a place in the firm's heart, McCarthy said.

“Those sectors were 3% of our portfolio a dozen years ago, now they’re more than 80%. We’ve got that right, and that has allowed us to perform in a choppy environment, but [it has] also given us so much data to go on the offensive now in those sectors where we shine the brightest.”

Blackstone is a bellwether for the industry as the manager with the largest portfolio in real estate — $326B at the end of 2022. It got there by making large profits on huge deals during and after the 2008 financial crisis, so how it spends its latest opportunity fund in the most significant period of disruption since then will be closely watched by the market. 

McCarthy told Bisnow where the new fund will be putting its money and where it will hold back, namely traditional offices, and why the current volatility is different than the post-Lehman Brothers crisis, but will still offer up enticing deals.

“We’re starting to see interesting opportunities where you have willing sellers, what I’d call motivated sellers,” McCarthy said.

“Real estate is being painted with a pretty broad brush as if everything is the same, but the sectors we’re focusing on are actually in good shape. We’re starting to see deals where the assets themselves tend to be high-quality, we can build conviction around them. But the seller needs liquidity, and these are the most sellable assets in their portfolio.”

Blackstone has been sitting on $24B of its $30B haul since the middle of last year. As of the end of 2022, it had only spent $674M of that, its annual report showed. Like everyone else in the market, the company has been waiting for the shrinkage of the gap between what sellers think an asset was worth yesterday and what buyers think it will be worth tomorrow.

That moment is coming, McCarthy said, as owners increasingly need capital to complete business plans and developments, or to refinance assets in a very different financial environment to that in which they purchased them.

This time around, it won’t involve huge waves of sales precipitated by banks. But borrowers will need to sell at prices low enough for buyers to make good returns. 

“Across the financial system, capital is more constrained,” she said. “Borrowing costs have risen, so business plans that had debt service ratios that worked when base rates, especially in Europe, were negative, those capital structures potentially don’t work today. It doesn’t mean that the distress will be as palpable as at other times maybe, but you’re going to need to work through the recapitalisation of some assets and the liquidity pressures some owners will have.”

McCarthy pointed to two recent deals as examples where buyers needed liquidity and Blackstone liked the assets for sale: a portfolio of six logistics properties in the region around Toronto, bought from the asset management arm of Toronto-Dominion Bank for $297M; and a portfolio of 47 properties in Sweden bought from Swedish listed property company Corem for $537M.

In both cases, the assets were bought at a discount to replacement cost of about 30%, she said. 

“There’s no signal that everything is all clear, but as more stability comes to financial markets, you will see transactions increasing,” she said.

The deals also demonstrate that when it comes to asset classes, the disruption in financial markets has not changed Blackstone’s convictions about the real estate sectors it favours one iota. 

McCarthy referenced a statistic used frequently by Blackstone Chairman and CEO Steve Schwarzman and Chief Operating Officer Jon Gray on a full-year results call in February: Eighty percent of Blackstone’s real estate portfolio is in industrial, rental housing, data centres, hotels, medical offices and life sciences. 

These sectors are still seeing strong rental growth, offer a good hedge against inflation and have macroeconomic factors supporting their growth, McCarthy said. In other words, it’s what Blackstone been buying for the last decade, and it’s what it will continue to buy. 

“One of the things about the negative sentiment you’re seeing, it’s not just affecting the investment market, it’s affecting new supply as well,” she said. “Debt costs have gone up, construction costs have gone up. So that new supply you would have seen coming through in a few years just isn’t going to be there, so we’re continuing to see high rates of rental growth.”

In industrial and logistics, the balance between supply and demand is still leading to record rental growth, McCarthy said, pointing to a recent Prologis results call indicating rents are still rising at record rates in many markets around the globe.

Housing in the U.S. has elevated new supply, but that is against a backdrop of a deficit of 4 million to 5 million homes needed to meet population growth. Other countries' construction remains subdued. And while tech companies may be cutting jobs, large global hyperscale cloud computing providers are still taking huge amounts of new space in the data centre sector. 

“We’re always looking to invest in those sectors that benefit from global macro tailwinds and sell out of those sectors facing headwinds,” she said.

Talk of headwinds leads, inevitably, to offices. Another stat Blackstone has been reaching for a lot of late is that only 2% of its portfolio is in traditional offices in the U.S. That compares to about 61% in 2007.

Blackstone has huge amounts of capital to deploy into office assets and companies that need capital fast at a time a huge number of offices in big cities across the world need it.

An unofficial mantra of the company when it comes to its property opportunity funds has been "buy it, fix it, sell it”, so office and Blackstone should be a match made in heaven with tens of millions of square feet of offices that need to be bought, fixed and sold. But McCarthy showed no appetite for buying big into the sector, pointing out that it has been getting harder to make money in traditional offices for almost a decade, let alone since the pandemic. 

“We started pivoting away around 2015-2017,” she said. “Even before the pandemic, it was a capital-intensive business. Tenant demands were getting greater and greater, and attracting them and retaining them became more and more capital-intensive. That’s when office lobbies started to look like hotels — that has a cost.”

An increasing amount of tenant interest is going toward smaller spaces in the best-quality offices, and those offices are doing well, with rents rising, she said. Yet creating that space is getting harder and more costly, especially as tenant sustainability needs increase.

That means there is little sign of Blackstone's 2% rising in the near future.

In terms of its existing office portfolio, the value of Blackstone’s assets suffered along with the rest of the market  as interest rates rose. Assets in its opportunistic funds dropped 2% in the last quarter of 2022, up 7% on the whole year, while its core-plus assets dropped in value by 1.5%, up 10% on the whole year. 

As early as the first half of 2021, Blackstone and COO Gray warned that inflation would be more persistent than others expected. The consensus at that point was high inflation was just a post-pandemic blip and resulting interest rates would rise, hitting asset prices.

McCarthy said Blackstone's pivot into sectors like industrial, housing and data centres arose from the conviction that interest rates wouldn’t stay low forever and that the firm’s portfolio needed to be structured to reflect that, focusing on sectors with the right balance of supply and demand. 

With its experience restructuring huge loans and portfolios like Hilton and Equity Office Properties in the wake of the last crisis, it tries to structure deals that are as resilient to changes in capital markets as possible. 

In its BREIT fund, where it holds assets longer, 90% of loans are fixed-rate for an average of 6.5 years to lock in low interest rates for as long as possible. For its opportunity funds, it uses mainly floating rate debt to allow it to refinance or sell when it needs to.

The huge size of its new fund means it can use more equity in the current market, where debt is more expensive and harder to access, then add more debt later on to boost returns — or sell if it has completed its business plan and can hits its target return, McCarthy said.

That strategy works as long as an asset is bought at the right price. 

“The capital structure is temporary, but the price is permanent,” she said. 

The size of the new fund also allows Blackstone to do a variety of deal types, some of which require a size and speed other investors can’t match. It will look at transactions from taking public companies private to building platforms by hoovering up smaller and midsized assets and portfolios.

McCarthy denied that having so much money to spend makes the company a forced buyer at a time of little clarity over where the market is going. 

“The advantage of the structure of a draw-down fund is that you can be patient, and we’ve shown that with this fund so far,” she said. “We appreciate that our investors have given us that ability because it’s very valuable. I’d rather be investing in a market where others are pulling back. That’s where the best performance comes.”