Investor Doubts Rise as BREIT's Stability Comes Under Scrutiny

In 2017, Blackstone, the world's largest private equity firm, traditionally catering to big institutions and the wealthy, made a pivotal move.

by Faruk Imamovic
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Investor Doubts Rise as BREIT's Stability Comes Under Scrutiny
© X/Reuters

In 2017, Blackstone, the world's largest private equity firm, traditionally catering to big institutions and the wealthy, made a pivotal move. It introduced BREIT, a private fund focused on commercial real estate, extending an opportunity to ordinary investors to partake in what it touted as an "all-weather strategy" for long-term wealth creation across various market cycles.

This venture into accessible investment was met with enthusiasm. By offering an attractive annual dividend of approximately 4% at a time when interest rates hovered near zero, BREIT quickly rose to prominence. By 2021, the fund was drawing in up to $3 billion a month from new investors, amassing assets worth $114 billion—accounting for about 8% of Blackstone's fee-earning assets—and generating over $5 billion in management and performance fees.

Skepticism Among Investors

However, the past two years have seen growing skepticism about BREIT's stability and reliability. Initially, the fund reported an annualized net return of 10.5%, nearly double that of an index of publicly traded REITs, even outpacing comparable funds amid a battered commercial real estate market post-pandemic. Yet, doubts began to surface in the fall of 2022 when the Federal Reserve's interest rate hikes unsettled the market, prompting investors to withdraw more than $15 billion from BREIT. In response, Blackstone invoked a clause that allowed it to delay these redemptions, a move that did little to calm the market and saw its shares tumble by nearly 20%.

More recently, Blackstone's CEO, Steve Schwarzman, expressed optimism, noting that all redemption requests received in February were fulfilled, and anticipating a rebound as evidenced by Blackstone's stock recovering almost 50% from its lows. "I believe we'll look back at 2023 as the cyclical bottom for our firm," Schwarzman remarked during an earnings call in January.

The Risks and Realities of Investing in Blackstones Private Real Estate Fund
The Risks and Realities of Investing in Blackstones Private Real Estate Fund© Getty Images/Mat Szwajkos
 

Underlying Concerns

Despite these optimistic projections, seasoned analysts, accountants, and investors have expressed concerns that BREIT might be overvalued. The returns claimed by the fund rely heavily on its own assessments—assessments that some believe are excessively inflated. For instance, Nate Koppikar, a hedge fund manager at Orso Partners, labeled the situation as "the absolute definition of a Ponzi scheme," citing the fund's reliance on new investor money to fulfill redemption requests.

Craig McCann, a financial analyst and former SEC economist, has been vocal about his reservations: "Surveying some of the ways that Blackstone has misled investors over the past five months, we are more convinced than ever that BREIT is a bad investment created for the benefit of Blackstone," he wrote.

The accuracy of BREIT's net asset value (NAV), a critical measure of the fund's worth, is also under scrutiny. Unlike publicly traded REITs that adjust their NAVs based on real-time market conditions, BREIT's monthly adjustments—dubbed "mark to magic" by critics—do not reflect the rapid changes in the real estate market. This practice led Chilton Capital Management to conclude that BREIT significantly overstates its NAV, potentially by more than 55%.

Blackstone maintains that comparisons to publicly traded funds are unfair, arguing that BREIT is inherently less volatile due to its superior asset selection and minimal exposure to urban office spaces. However, the company's claim faces challenges from the ongoing decline in commercial real estate values and the speculative nature of some of its most valuable assets, like undeveloped data centers.

Moreover, BREIT's structure raises additional concerns. The fund's hefty dividends are supported in part by selling assets or borrowing, a precarious model that could lead to financial instability if interest rates remain high. This reliance on favorable market conditions poses a significant risk to investors, especially those who might be last in line during a potential asset sell-off.

Investor Impact and Calls for Transparency

The unfolding narrative of BREIT presents a critical examination point for investor impact and the growing calls for transparency within private equity ventures. As Blackstone’s BREIT continues to maneuver through turbulent market conditions, the potential for substantial financial repercussions for individual investors cannot be understated. Many are left pondering whether their investments are as secure as once promised, or if they are merely caught in an investment whirlwind that prioritizes institutional benefit over individual gain.

The structure of BREIT’s dividend payouts has been a particular point of contention. Initially, the fund attracted investors with its high dividends, comparable to safer bond investments. However, the sustainability of these dividends has come into question. It's crucial to note that a significant portion of these dividends was not generated from the fund’s operating cash flow but through additional shares or by drawing from reserves. This scenario raises concerns about the real earning power of the assets under BREIT’s management.

The situation is further complicated by BREIT's handling of redemption requests. In 2022, when investors began pulling out in large numbers, BREIT was forced to slow down redemptions, citing cash flow concerns. This has led to suspicions that the fund’s liquidity is not as robust as its portfolio size might suggest. The practice of paying dividends in shares rather than cash has also diluted the value of existing shares, compounding investor losses.

BREIT Faces Growing Investor Skepticism Amid Market Volatility
BREIT Faces Growing Investor Skepticism Amid Market Volatility© Getty Images/Mario Tama
 

The Challenge of Asset Valuation in Private Funds

The core issue that exacerbates BREIT's challenges is the valuation of its assets. Unlike public companies, whose asset values are continually scrutinized by market forces, private funds like BREIT operate with a significant degree of opacity. This lack of transparency allows BREIT to maintain asset valuations that might not reflect true market conditions—a practice that some analysts have likened to a "mark to magic."

For example, Blackstone’s assertion that its NAV is adjusted more rigorously than other REITs is difficult to verify independently because the calculations are not fully disclosed to investors or regulators. This secrecy is a critical vulnerability in the structure of private equity real estate investments, which traditionally rely heavily on internal assessments rather than market-driven valuations.

This valuation challenge is particularly acute in times of market stress. For instance, if BREIT's real estate assets are not as liquid as claimed, a rapid decline in their market value could leave the fund overvalued, potentially leading to significant financial adjustments if these assets need to be sold at a discount. This scenario could trigger a cascading effect on the fund's ability to fulfill redemption requests, pay dividends, and maintain operational stability.

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