Is Blackstone the canary in the commercial property coal mine?

Overnight we have perhaps seen a signal of something that worried us for some years. What I mean by that is that all the years of low interest-rates and of course negative ones in Japan and the Euro area would mean that interest-rate rises were likely to prove more difficult. I recall 3% being suggested as a level which as Taylor Swift would put it might cause “Trouble,Trouble, Trouble”. The situation was exacerbated by the way that central banks bought bonds and slashed interest-rates in some cases even lower in response to the Covid pandemic. So this from the Financial Times provides some food for thought.

Blackstone has limited withdrawals from its $125bn real estate investment fund following a surge in redemption requests, as investors clamour to get their hands on cash and concerns grow about the long-term health of the commercial property market.

The first point is that pressure has been applied in two ways. Firstly higher interest-rates raise borrowing costs with the Federal Reserve charging just under 4% and as it happens bond yields if we exclude the short-end being similar. So borrowing is more expensive and that leads to the second effect where we expect property prices to fall. Only yesterday we looked at the recent falls in the Case-Schiller index for US property and for our purposes today this is the relevant part.

“Despite considerable regional differences, all 20 cities in our September report reflect these trends of
short-term decline and medium-term deceleration. Prices declined in every city in September, with a
median change of -1.2%”

This is because this fund holds quite a lot of rental housing.

A majority of the fund is in apartments (about 55%) ( @GRDecter )

So we quickly are on alert as we note that it is expected further falls which are the real issue here. What has happened so far?

Back to the Financial Times.

The private equity group approved only 43 per cent of redemption requests in its Blackstone Real Estate Income Trust fund in November, according to a notice it sent to investors on Thursday. Shares in Blackstone fell as much as 8 per cent.

So the problem had in fact been building but was in the shadows until the declaration. These things always have a first mover advantage which is one of the reasons why they are in fact rather risky. In a sense it is like a run on a bank in that they only have a certain amount of cash and liquidity available so in any crisis there is an incentive to run for the hills. Also the environment has not only darkened in residential property.

In the US, commercial property is under pressure from rising inflation and interest rates, according to a recent report from the National Association of Realtors. Globally, the mood in property has darkened and some high-profile investors have warned of a lack of finance in parts of the sector. ( FT)

So the outlook is dark and there is a problem with leviathans like this.

The withdrawal limit underscores the risks wealthy individuals have taken by investing in Blackstone’s mammoth private real estate fund, which — after accounting for debt — owns $69bn in net assets, spanning logistics facilities, apartment buildings, casinos and medical office parks.

I think we can safely say that the $69 billion net asset value has been assigned to history. Also these sort of funds are not exactly nimble so in general you should only have a a small proportion in them. Did these all remember that?

About 70 per cent of redemption requests have come from Asia, according to people familiar with the matter, an outsized share considering non-US investors account for only about 20 per cent of Breit’s total assets. One partner in the fund told the Financial Times that the poor recent performance of Asian markets and economies may have put pressure on investors, who now need cash to meet their obligations.

That is a clear fail in itself because if you thought you might need cash you should not be in this sort of fund, or to be more specific put a tranche in one where you can get cash reliably. Maybe there has been an additional factor in that if people did that and say used a bond fund presumably a US Dollar one then they would have lost money in 2022. In spite of the recent improvements the US 30-year yield at 3.63% is more than double what it was at this time in 2021. So perhaps things looked better in the commercial property fund ironically putting it under pressure.

On that road we have perhaps a rather familiar “mark to model” issue where the bet asset value does not fully reflect the real world and thus has made withdrawals more likely. That is reinforced by this.

 The fund has returned more than 9 per cent in the nine months to the end of September because of rising rents from the properties and dividend payments.

Getting the cash

To be fair to Blackstone their system has worked well in two ways here.

The surge in redemption requests come as Blackstone announced the sale of its near 50 per cent interest in the MGM Grand Las Vegas and Mandalay Bay Resort casinos in Las Vegas for $1.27bn. Including debt, the deal valued the properties at more than $5bn. Proceeds from the sale, which was agreed at a premium to the carrying values of the properties, will help with liquidity for Breit as it meets redemption requests — or be reinvested in faster-growing property assets, said a person familiar with the matter. ( FT)

The first point is the simplist which is that they had something they could sell relatively quickly which is far from always the case. Also in this instance it seems to was valued fairly. Care is needed as that may be why it was the one sold but initially their procedures are holding up. But in the end this sort of fund will always have to cap any flow.

The Breit fund allows for 2 per cent of assets to be redeemed by clients each month, with a maximum of 5 per cent allowed in a calendar quarter.

The private fund managers should have been emphasising that.

Private capital managers have increasingly turned to retail investors, arguing wealthy investors should have the same ability as pension and sovereign wealth funds to diversify away from public markets. Part of the pitch money managers make is that, by giving up some liquidity rights, higher returns can be achieved. ( FT)

How many times have we seen something like this play out? It is like an oddly declining verb in that liquidity is only relevant when you badly need it, which of course is when it may be a case of South Park’s “And it’s Gone”

Comment

On a tactical level things are holding up pretty well as Blackstone set clear rules for withdrawals and has been able to realise a sold tranche of cash both promptly and without dilution. That leads to the question of can they keep it up? But so far so good.

On a more strategic level there is the issue that new borrowing is more expensive now and property values are falling. Also I worry about this from JP Morgan in FT Alphaville.

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.

With even the best other funds losing more than 10% and some over 30% how has Blackstone made a profit here? Even the best fund managers seem unlikely to have been that good. It also provides an irony because if you have several commercial property funds you will only have one making money and so will most likely withdraw from it. Not necessarily logical but human nature.

Also whilst they have the ability to effectively close the fund it would send out a dreadful message.

Blackstone can basically just turn it into a closed property trust at will, and reopen for redemptions when they want.

We return to the twin issues of ZIRP making investors search for yield and commercial property where the investment vehicle always allows in but not always outs.