Maybe the Outlook isn't so BREIT

Business Insider raises questions about BREIT's claimed valuations and returns. As blog readers will know, UC's chief investment officer - on his own motion - bailed out BREIT with $4.5 billion of pension and endowment funds when it was experiencing a slow-motion run on the bank in return for a promise of a special extra-high return. Only one regent on the Investments Committee raised any concerns about that transaction: 

In 2017, Blackstone — the world's largest private-equity firm, which usually caters to big institutions and the very wealthy — decided to give ordinary investors an opportunity to get in on the firm's magic. It created BREIT, a private fund that buys commercial real estate like warehouses and apartment buildings, and marketed it to everyday investors as an "all-weather strategy to build long-term wealth across market cycles."

And it was magic: By offering an annual dividend of about 4% in a world where interest rates were close to zero, BREIT quickly became a giant. At its peak in 2021, the fund was attracting as much as $3 billion a month in new investments. Today, BREIT boasts assets of $114 billion — about 8% of Blackstone's entire fee-earning assets — and has generated over $5 billion in management and performance fees.

But over the past two years, some investors have grown suspicious that BREIT isn't the rock-solid investment Blackstone claims it is. Since its inception, the fund says it has delivered an annualized net return of 10.5% — almost double an index of publicly traded REITs. Even as commercial real estate has been battered in the wake of the pandemic, BREIT has somehow managed to defy gravity, outperforming comparable funds by seemingly fantastic margins. In the fall of 2022, after the Fed's interest-rate increases began to shake the commercial real-estate market, investors began asking for their money back — more than $15 billion to date. Faced with a run on the fund, Blackstone cited a provision that allowed it to take its time refunding antsy investors — a decision that only served to further alarm the market. Shares in Blackstone tumbled by nearly 20%. Last year, BREIT failed to generate enough cash to cover its annual dividend.

In recent months, the fund has appeared to recover from the debacle. BREIT announced it was able to fulfill 100% of the repurchase requests it received in February, which had slowed to just under $1 billion. Amid the promise of a rebound, Blackstone's stock has regained almost 50% from its lows. "I believe we'll look back at 2023 as the cyclical bottom for our firm," Steve Schwarzman, Blackstone's CEO, told analysts at an earnings call in January.

Blackstone signage outside Blackstone Group headquarters in NYC

Investors in Blackstone's real-estate fund asked for their money back in droves — more than $15 billion to date. Jeenah Moon/Reuters

But the rosy picture that Blackstone paints may not tell the whole story. In recent months I've spoken with veteran analysts, accountants, and investors who have come to believe that BREIT is essentially a house of cards. That's because the returns the fund claims it has delivered depend almost entirely on BREIT's own estimates, which skeptics believe are wildly inflated. What's more, when BREIT faced a flood of redemption requests from investors, it only fulfilled all those requests after raising cash from new investors — including one that received a sweetheart deal from Blackstone to invest in BREIT. "It is the absolute definition of a Ponzi scheme," said Nate Koppikar, who runs a hedge fund called Orso Partners that has shorted Blackstone's stock because of concerns over BREIT. Unless the real-estate market comes roaring back, analysts warn, BREIT could end up shrinking to a fraction of its current size, leaving the fund's investors holding the bag.

"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," Craig McCann, a financial analyst who served as an economist at the Securities Exchange Commission, wrote last year. "Investors should not accept anything Blackstone and BREIT state as truthful."

It's impossible to know exactly how valuable BREIT is. Because the fund is not publicly traded, the market doesn't set its price per share — Blackstone does. You buy shares in BREIT based on your faith in Blackstone's investing brilliance and in the firm's account of its own performance. Investing in a private real-estate trust like BREIT is, ultimately, an exercise in trust.

BREIT's returns are based on a measure called net asset value, or NAV. That's supposed to be the value of all the assets the fund owns, minus its debt. Blackstone told Business Insider that it has an "incredibly rigorous valuation process" — one it says has led it to adjust its NAV more aggressively than other REITS. But BREIT doesn't let investors or regulators see some of the crucial assumptions that go into calculating its NAV. As BREIT's financial documents state, Blackstone "is ultimately and solely responsible for the determination of our NAV." The methods used to calculate it are "not prescribed by rules of the SEC or any other regulatory agency," and the NAV "is not audited by our independent registered public accounting firm."

Chilton Capital Management, which invests in publicly traded REITs, analyzed the way Blackstone adjusts the value of BREIT to reflect changes in the underlying real estate it owns. Rather than being "marked to market" every day — or every millisecond, like public REITS — Blackstone adjusts its NAV on a monthly basis. In today's volatile real-estate market, that means its stated value can lag way behind reality. "It inherently is a flawed process when prices are changing quickly," Chilton observes. "We refer to this imperfect appraisal process as 'mark to magic.'" In 2022, after the crash in commercial real estate, publicly traded REITs that own assets similar to BREIT's — multifamily housing and industrial buildings — have been selling at sharp discounts. But BREIT, by "marking to magic," has continued to claim far higher returns. Using a collection of market-based metrics, Chilton concluded last April that BREIT was overstating the value of its NAV by more than 55%.

​​McCann, who is now a principal at SLCG Economics Consulting, reached a similar conclusion. He calculated that the cumulative returns of other funds in the sectors in which BREIT is concentrated plunged by over 30% in 2022. Yet BREIT claimed that its value increased during the same period. In the dry language of market analysts, McCann called the fund's claims about its NAV "unreliable."

Blackstone considers such comparisons unfair. It insists that BREIT shouldn't be compared to publicly traded funds, which it argues are more volatile than private offerings. In a statement to BI, the firm insists that BREIT is able to outperform other funds for a simple reason: because it owns better assets than they do. BREIT's portfolio, Blackstone says, is "concentrated in the best performing sectors (data centers, logistics and student housing) and geographies (virtually no urban exposure)." Only 3% of BREIT's holdings are in office buildings, which have been ground zero for commercial real estate pain. The company points to its performance during the global financial crisis of 2008 as evidence of its ability to outperform its competitors during "periods of dislocation" and notes that it has sold $20 billion of real estate since the beginning of 2022, when interest rates began to rise, generating a profit of $4 billion.

"Not all real estate is created equal," BREIT boasted in a recent letter to stockholders, "and where you invest matters."

But Blackstone's principal claim — that sounder investments have led to higher returns — is difficult to square with the ongoing decline of commercial real estate. It's hard to fathom how BREIT could have bought so many properties at the height of the market and yet somehow been selective enough to have dodged all the post-pandemic downturns suffered by other funds. According to BREIT's own numbers, data centers and student housing make up only a small part of its portfolio. And many of the data centers Blackstone says have already created so much value for the fund aren't even up and running yet — they're still in development...

Full story at https://www.businessinsider.com/blackstone-breit-commercial-real-estate-fund-misled-investors-private-equity-2024-5.

See also https://www.nytimes.com/2024/05/07/business/dealbook/blackstone-breit-fund-debate.html.