'Rational To Be Anxious’: What Happens Next After Blackstone, Starwood’s Withdrawal Freeze

Investors are lining up to take their money out of nontraded REITs after pouring in tens of billions in recent years, which allowed fund managers like Blackstone and Starwood to dominate the commercial real estate market with huge portfolio acquisitions.

Now these types of funds, which didn’t exist during the Great Financial Crisis, are in uncharted waters.

Blackstone and Starwood’s nontraded REITs have both told investors in the last week that they are limiting redemptions after requests in November exceeded their monthly and quarterly limits. The $69B Blackstone Real Estate Investment Trust told investors Dec. 1 it was limiting November redemptions to $1.3B, with each investor receiving roughly 43% of their requested amount.  

This marks the first time in the five-year history of these funds that they have enacted limits on investor redemptions.

The raising of the gates, as the limits are known, has created anxiety among investors, and the CRE industry more broadly, about what will happen in the coming months if investors keep trying to pull their money out of the funds.  

The concerns center around two key questions: Will Blackstone and Starwood be forced to sell assets to fund investor redemptions? And will they write down the net asset values of their properties?  

“The question in the ether is ‘Wait a minute, how come all the data sources are telling us the value of assets have gone down, cap rates have gone up, but BREIT continues to post … values above where they were a year ago?’” said Georgetown University professor Jonathan Morris, an industry veteran who teaches a master's-level course on REITs. “That question has yet to be answered, and I don’t know what the answer is, but it’s sort of giving investors heartburn.”  

The funds both tell investors in prospectus documents that they retain the right to limit redemptions — which they call share repurchases — according to their own judgment, and they each set limits for the total amount of shares that they will repurchase of 2% of their total net asset value per month, and 5% of NAV per quarter. But they have the ability to exceed the limit if they choose, as BREIT did in the first quarter of 2020 and in October of this year.

This structure of nontraded REITs, serving as perpetual investment vehicles that set caps for monthly redemptions, has only existed since 2015, as prior to that, funds typically had finite life cycles after which they would fully liquidate. BREIT and SREIT, the two largest of the nontraded REITs, were both launched in 2017.   

According to Robert A. Stanger & Co. CEO Kevin Gannon, whose firm tracks nontraded REITs, November represents the first month ever in which these funds have chosen to halt redemptions. And this nascent segment has never seen investors try to pull out money at this scale.  

Investor redemptions across the nontraded REIT sector totaled $3.68B in the third quarter, up from $2.88B in the second quarter, which was the first time they had ever exceeded $1B, according to Stanger data. BREIT, by far the largest nontraded REIT, granted $3.05B of redemptions in Q3, with Starwood’s SREIT granting $361M, according to Stanger.  

“Those are big numbers,” Gannon said. “It’s bigger than the current level of fundraising.”  

This surge represents a stark reversal for a segment of funds that had previously been bringing in money at a record pace: Nontraded REITs raised $35B last year and $31B through October of this year, according to Stanger data.

The funds had also been on a rapid buying spree, with BREIT alone closing $22B in take-private acquisitions of public REITs since 2018, in addition to its huge purchases of private property portfolios.  

Heads of the two companies have spoken publicly over the last two days to try to quell market concerns about the redemption limits. Starwood CEO Barry Sternlicht said at a New York conference Wednesday that “It isn’t a run on the bank … This isn’t FTX,” adding that these funds weren’t intended to provide fast liquidity, The Real Deal reported.  

Blackstone CEO Stephen Schwarzman said at a separate conference that investors were pulling out money because of overall market volatility rather than because of dissatisfaction with the fund, Reuters reported.  

Will Starwood And Blackstone Sell More Assets?  

The question around a possible sell-off could have major implications for the commercial real estate market. These nontraded REITs have been among the most active buyers of large portfolios in recent years, and if they start instead looking to sell more assets, it could further depress commercial property prices in what has already become a down market.  

A source close to BREIT told Bisnow Thursday afternoon that the fund’s buying activity next year will likely be slower than it was in recent years. The source added that the fund will likely look to sell assets, especially ones outside of BREIT’s two fastest-growing sectors, residential and industrial, which collectively make up 80% of its portfolio. BREIT also owns data center, hospitality, self-storage, office and retail assets.  

Last week, BREIT agreed to sell its 49.9% stake in the MGM Grand Las Vegas and the Mandalay Bay to Vici Properties, which already owns the majority stake, for $700M.  

The source close to BREIT said part of the calculation of those sales was making sure it had the flexibility it needed on its balance sheet to fund share repurchase requests, but it wouldn’t have done the deal if it weren’t selling it at a good price. BREIT doubled its initial investment with the sale.  

One investment manager said he has seen BREIT looking to sell more properties in recent weeks. Artemis Real Estate Partners Senior Managing Director Michael Vu, speaking on a Bisnow event Thursday, said BREIT put about a dozen assets on the market around Thanksgiving.  

Vu said said BREIT instructed brokers to solicit bids in a short time frame rather than to put together a full offering memorandum, and he said it received strong interest.  

“To everyone’s surprise, and it might be because there’s not many other competitive deals out there, there were more bids for those properties than anything else,” Vu said in response to a question from Bisnow. “If you say BREIT or SREIT is the seller, you almost get a premium … The pricing did not fall off or create new precedent in a negative way as some people might expect, and I think there’s still a lot of liquidity out there.”  

Given how aggressive the fund was in buying out public REITs and acquiring large portfolios, experts say a shift from buying to selling could have widespread implications for commercial property values.  

“The market is thin to begin with, and the largest buyer that had the largest available pool of ready capital where they didn’t have to enter debt markets or raise equity, if you take that out too, it just makes the market for this product type more illiquid, which drives the bid-ask further apart,” said Rob Simone, REIT sector head at Hedgeye, an independent research firm.  

He gave the example of a seller of a multifamily portfolio in the Sun Belt that may have expected to sell at a capitalization rate of below 5%, but with a smaller buyer pool today, it might not find anyone willing to buy at less than a 6% cap rate.  

“One of those two things have to adjust to the other, and I’d argue the more likely scenario is the sellers have to lower pricing requirements, and all else being the same, what’s going to happen is that has negative implications for values across the board,” Simone said.  

David Auerbach, a managing director at investment firm Armada ETF Advisors and author of The Daily REIT Beat newsletter, said he thinks BREIT has amassed an attractive portfolio and will be strategic about what it puts on the market. While it may not be able to achieve sale prices equal to the previous estimated value of its assets, he doesn’t think it will have to offer steep discounts.  

“It is high-quality stuff, there is going to be a natural buyer at the table, but the buyer’s going to know what’s going on at BREIT and react with bids accordingly based on what’s happening,” he said.  

BREIT has $9B in immediate cash on hand, plus billions more in debt securities, meaning it has enough money to fill investor redemptions for the near term even if they continue to reach the monthly cap. It also continues to raise new money, and the exact amount of runway it has depends on that fundraising.

Gannon estimated BREIT and SREIT could pay redemptions at the monthly cap until 2024 without selling any real estate, but he said they will likely sell properties to keep their cash around that level.  

“Between now and 2024, they’ve got to liquidate maybe some assets to build up the liquidity war chest so they never run out of cash, and that means ultimately they may have to sell real estate,” Gannon said.  

What About The Asset Values?  

Nontraded REITs have reported asset values going in the opposite direction of the rest of the market. Nationwide commercial property values have fallen 13% this year, according to Green Street’s Commercial Property Price Index. Nareit’s index of all publicly traded REITs is down more than 20% this year.  

At the same time, BREIT and SREIT reported the value of their portfolios increased 11.9% and 13.2% through the first nine months of this year, according to Stanger.  

“People are rational to be anxious about that a little bit, given everything we know,” Gannon said. “When interest rates go up, that usually means real estate values go down, so you expect to see more of that … If it was me, I’d be aggressive on taking that value down, but I’m not in charge.”  

According to BREIT’s investor materials, it calculates asset values using two primary factors: the cash flow of a property and an assumption of the cap rate it could achieve on the sale of an asset. It has increased its assumed cap rates by 14% for rental housing and 6% for industrial through the first 10 months of 2022, the investor materials said.  

The cap rate rising would make values fall, but it was more than offset by the cash flow growth of BREIT’s properties. Its net operating income for the first nine months of this year was up 13% from last year, which it said was 65% higher than the NOI growth of the publicly traded REIT index.  

The nontraded REITs report their values monthly, and Gannon said it typically happens around the 15th of the month. He thinks the NAV remaining elevated has been a primary reason why investors have sought to pull out their money, and he said if the nontraded REITs are raising money and repurchasing shares at a higher valuation than their assets are actually worth, then that is bad for the investment managers.  

“We should focus like a laser beam on their NAV,” Gannon said. “Because what [nontraded REITs] really want to do is raise more capital to cover those redemptions, and we want to do it efficiently, and we don’t want to raise that capital paying guys off at too high a price. You want to be careful how you let guys out, you don’t want the price to be too high when they’re getting out.”  

While keeping NAVs overinflated is cause for concern, there are also negative implications to writing them down. Most pressing is the investor redemption limits that have been put in the spotlight over the last week, which are calculated as a percentage of NAV.  

That means that if the funds write down the value of their assets, they would also be lowering the caps for how much they will pay in redemptions. Write-downs in NAV could also lead more investors to try to pull out their money and could hurt nontraded REITs’ fundraising efforts, further exacerbating the issue they face today.  

“There’s an incredible degree of skepticism,” Simone said. “How can you market this product to high net worth investors with all this negative news? From that perspective, it definitely hurts their ability to raise money."

Auerbach, whose firm offers ETFs that compete with nontraded REITs for investor dollars, said he thinks the last week has opened the eyes of the investment community to the structure of nontraded REITs and he said their NAV is now "under a microscope."

"This isn’t going away overnight, especially as the redemption queue keeps growing," Auerbach said. "This is not just simply going to be turned off and then suddenly everything’s better."