Top leaders at Blackstone inc
said they were amazed that so many private investors wanted their money back given the strong performance of their huge private real estate fund.
You shouldn’t be surprised. The fund’s design encourages investors to withdraw when they see others doing so. My concern is that the same stimulus could hit other parts of the financial system as central banks pull away from easy money.
A slow-motion cash frenzy is underway across the financial arena as the Federal Reserve sucks liquidity out of the system. Those who are hurting the most are those who have accumulated personal wealth without considering how much cash they might need.
The rationale behind the Blackstone Real Estate Income Trust, or BROAD, is that it raised $46 billion from ordinary investors, added debt and bought a number of properties, mostly apartments and warehouses in Sunbelt. It was good at it, or maybe it got lucky, and the value of the fund rose a lot, so it was very popular.
But that year, mortgage rates rose and recession fears mounted, and house prices began to fall. They’ve fallen just a little so far, and not everywhere, but enough to make it less obvious to investors that they should put money in a leveraged bet on home prices.
Blackstone isn’t stupid and thought ahead of time that one day people would want their money back. The contracts limit BREIT’s withdrawals to 2% of the fund each month, or 5% each quarter, to avoid the need for fired property sales. Now people want some of their money back and the limits have kicked in.
The problem is that BREIT’s investors now know that other investors in BREIT (and a similar fund owned by Starwood Capital Group, known as SREIT) are trying to pull out. Just like in a bank run, an investor who thinks others will try to exit should get out first. Even those who think things are about to settle down – and there are reasons that might be the case – should still be concerned about the impact of others’ departures.
It’s not just WIDE. Private debt funds have become very popular over the past decade, and mutual funds have been buying into private equity, part of increasingly creative attempts to make money in a world of zero interest rates. Some who hold hard-to-trade assets and allow withdrawals are also prone to self-fulfilling liquidity fears.
I see four weaknesses at BREIT that could also apply to other funds.
- Anyone who thinks they will still have to collect next year will be eliminated earlier than planned. Investors who attempted to withdraw in November only got 43% of what they asked for, and in December the cap will limit withdrawals far more. The longer the upper limit exists, the more people have to participate.
- Investors can buy much cheaper on public markets. Publicly traded REITs trade at a deep discount to the value of their holdings. Investors keen to own REITs managed by others could sell BREIT at the still-increased appraised value of its holdings and buy a publicly traded REIT at less than the appraised value of its holdings.
- BREIT borrows about $1 for every $1 in investor value, but as investors pull back, the proportion of its debt-funded holdings increases. That’s great when prices are rising — one of the main reasons for investing in real estate is that it can take advantage of a lot of leverage — but when prices are falling, more leverage amplifies losses.
- Withdrawals make the fund less liquid. BREIT has $9.3 billion in cash and banking facilities, so it will have no problem repaying investors who have asked for an exit and is far from having any liquidity problems. But as withdrawals continue, those who remain will hold a fund with less and less cash, giving it less flexibility to bargain in the markets or satisfy future withdrawals.
The third and fourth problems can be delayed by Blackstone selling buildings, as it just did with its stake in the MGM Grand and Mandalay Bay casinos in Las Vegas, or converting the billions of dollars in other easily sold assets into cash. Delay long enough and investor concerns could ease.
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Hedge funds discovered all of these problems in 2008 as clients rushed to the exits. Their ventures into unlisted assets — often pre-IPO stocks, but some funds bought assets as exotic as African farmland and art — left many investors with hastily created “side pockets” of unsold items from their funds. Others simply refused to allow withdrawals to avoid penalizing remaining investors.
Blackstone says pullbacks from BREIT have primarily come from foreign investors, particularly from Asia, who were hit by margin calls as Hong Kong stocks plummeted, according to chairman and CEO Stephen Schwarzman. You don’t want to invest with people like that because they become forced sellers when the market falls.
Ultimately, it’s a trust game. If you think others have lost faith, it makes sense to withdraw as well. That’s why Blackstone goes out of its way to point out all the good things about BREIT — which this year includes a cool $5.1 billion made from interest rate derivatives.
“Our business is based on performance, not cash flows, and the performance has been rock solid,” said Blackstone.
The problem Blackstone and its peers face is that they’re selling illiquidity in a world that increasingly demands liquidity.
Write to James Mackintosh at [email protected]
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