BREITing bad

Yesterday Blackstone’s giant property vehicle BREIT limited withdrawals, triggering a mild case of PTSD among some financial crisis survivors. Are they right to hyperventilate?

FTAV readers will know that we have been a tad concerned at how BREIT will do in a more hostile economic-financial environment. But we also think it should be noted that recent headlines actually show off some of BREIT’s better aspects.

Whatever you may think about Blackstone, they’re not dummies. They knew that a vehicle designed to buy huge portfolios of illiquid real estate and to be offered to rich retail investors is a recipe for disaster if they can withdraw their money whenever they want.

That is why BREIT — to its credit — imposes clear and transparent limits on how much investors can withdraw. Here’s a snapshot of those offering terms, with our red underlining.

This isn’t fine print stuff. Blackstone is very open about the fact that this is not a liquid investment portfolio à la a mutual fund, and gates can and will go up whenever it feels that it is necessary.

And that is what has now happened. It seems that mainly Asian investors in BREIT have been yanking money out so aggressively that they hit the withdrawal limit (the vehicle is structured so that withdrawals happen in the form of BREIT buying back shares from exiting investors).

But it’s hard to see how BREIT could spiral into a liquidity mismatch doom loop, where investor withdrawals force asset firesales and spur further redemptions etc. Blackstone can basically just turn it into a closed property trust at will, and reopen for redemptions when they want.

Some of the doom-mongering we’ve seen online therefore looks hugely overdone. This is not Blackstone itself suffering liquidity issues, and it is certainly not a redux of the summer of 2007.

However, this is obviously still not great news. And the fact that it is happening at a time when BREIT’s headline performance still looks good is disconcerting (we assumed that the crunch would first come when more realistic property valuation marks and falling rents might sour BREIT’s headline performance and crimp its distributions).

As JPMorgan analyst Kenneth Worthington puts it this morning:

Will this cause a run on the bank? We don’t think so, but sales seem poised to be under further pressure. We acknowledge that capping redemptions is a poor look for BREIT. Part of the allure for BREIT had been the availability of monthly liquidity in a high-quality, non-traded REIT. But now that BREIT redemptions are capped, we can envision retail/financial advisors thinking twice before allocating new capital to the fund. Furthermore, we see the velvet rope now limiting redemptions possibly if not likely driving more investors to ask for more of their money back. What may be a bit more concerning is that performance does not appear to be directly driving outflows given returns are excellent in 2022TD with the fund up ~9% through October. Indirectly, we see potential for those seeking liquidity to sell BREIT as a winner in 2022 potentially for reinvestment in other parts of real estate that have underperformed.

Not a forced seller, but liquidity demand could weigh on returns. If there is good news, it is that BREIT has plenty of liquidity with what appears like a remote chance of being a forced seller. Here, BREIT had cash on hand of $1.4bn on Nov 11, and a credit facility of $7.9bn. The fund also has real estate debt of $9.9bn that can be liquidated. Through September, operating cash flows were $2.2bn. We estimate the current size of BREIT has fallen to ~$65bn with the November redemption and some asset depreciation, which would cap quarterly redemptions at $3.3bn initially. Here, debt sales, operating cash flow, the sale of MGM and the credit facility position BREIT well to withstand two years of maximum outflows. However, if BREIT starts to borrow to meet redemptions or if it were to take losses on debt sales needed to fund liquidity needs, BREIT performance could deteriorate and weigh on returns. Underperformance could sustain redemptions.

This is not good news for Blackstone. As Bryce pointed out in Further Reading this morning, BREIT has been a major component of the company’s growth in recent years — especially in fee terms, where it now accounts for almost a fifth of earnings — and “asset managers that stop growing tend to be valued a lot lower than those that keep growing”.

Fintwit’s grouchiest billionaire certainly wasn’t convinced by Blackstone’s defence.

“Our business is built on performance, not fund flows, and performance is rock solid.”

When we were long great businesses at cheap prices and short overvalued crap in 2020 we were rock solid too in our OWN OPINION.

Do these guys believe their own bull? https://t.co/ikQKVi4Swm

— Clifford Asness (@CliffordAsness) December 1, 2022

More broadly, it does raise questions as to whether more fickle retail investors — no matter how wealthy they are — should have easy access to private market funds like this. Even when they are appropriately structured there are many ways it can go wrong.

And at a time when people are already worried about the impact of aggressive interest rate increases on the global property market, the sight of America’s biggest private landlord gating its crown jewel real estate fund is not a great sign.

This chart from EconomPic on Twitter certainly underlines the discrepancy between BREIT and its publicly-traded peers . . .