Property problems

In our last blog, we looked at some of the dynamics playing out in residential real estate in Canada and the UK. A simple summary of those dynamics would be that valuations may well come down but there are also a number of factors at play which could support them. At the same time, REIT discounts have widened substantially, so even if there are declines in NAVs, it’s possible they’ve been baked into share prices to some extent already.

Over in the US, this week saw an interesting deal play out involving private equity group Blackstone. The company announced on Tuesday that UC Investments, which manages the University of California’s pension and endowment funds, will invest $4bn in shares of Blackstone Real Estate Income Trust (BREIT).

On the surface this seems like a positive development. According to its latest performance update, BREIT, which is not exchange-traded, saw NAV total returns of 8.4% from the start of 2022 until the end of November for the Class I shares that UC Investments will be investing in. The fund manager will be buying the shares at that latest valuation.

However, there are a couple of points that do not inspire great feelings of confidence. One is that BREIT had to stop redeeming shares last quarter. The fund has a quarterly limit, equal to 5% of NAV, on redemptions. That so many investors were eager to redeem suggests they believe the NAV, which is set by Blackstone, may not be sustainable and were thus eager to exit at a high point.

The investment from UC Investments is also not just a simple cash purchase of shares in the fund. Instead, the funds are locked in for six years and Blackstone has promised the manager a minimum 11.25% annual return over that period. The shares will be kept in a separate fund, where Blackstone has put down $1bn-worth of its shares in BREIT to make up for any potential shortfall in returns.

This looks an awful lot like a type of debt investment as a result. UC Investments will, at least in theory, receive a predefined minimum return on its investment and BREIT, in the form of shares, is having to put down a kind of collateral as an assurance that it will be able to pay out if returns are below that threshold. The potential upside for BREIT’s managers is that any returns in excess of 11.25% would result in them getting a 5% performance fee.

What to make of this? On the one hand, you could argue it validates BREIT’s NAV, will help stave off further redemptions and is a sign of confidence that the fund will be able to continue delivering strong returns in the years ahead.

But then it could be seen as a bailout - an attempt to prop up a NAV that no longer reflects reality and ensure redemptions can continue. If investors were to max out redemptions to the 5% level this quarter then, at the current NAV valuation of $69bn, the managers would need to pay out close to $3.5bn.

At the end of September 2022 BREIT claimed to have $9.3bn of “liquidity”. However, only $1.4bn of that amount was in cash and cash equivalents. The remainder was derived from access to $7.9bn via a revolving credit facility. Given the managers will not want to become forced sellers or use credit facilities to meet redemptions, it’s plausible the cash from UC Investments will be used to meet redemptions in the short-term.

Whether or not that is sustainable long-term remains to be seen. If redemptions continue and valuations do come down, then it’s going to result in serious problems for BREIT. But six years is a long time and, although it’s plausible we’ll see a decline in valuations over the next couple of years, it’s difficult to say what happens beyond that.

Past performance is not a reliable indicator of future results