REIT deals getting creative amid weary commercial real estate market

When Blackstone Inc. put a portfolio of student dorms up for sale, it worked behind the scenes to make the deal even more attractive.

First, the firm dangled the option for buyers to take over $800 million in debt that had already been negotiated at low rates. And after bids came in, Blackstone stepped up as a provider of below-market financing, bringing the total package to about $1 billion.

KKR & Co. won the deal, agreeing to buy the properties from the $59 billion Blackstone Real Estate Income Trust. The sale was announced in time for a crucial April shareholder call, when President Jon Gray said the 7% premium BREIT got for the dorm sale was among “inconvenient facts for our critics.”

The private negotiations, described by five people familiar with the process, underscore how real estate owners are digging deep into their financial toolkits as they look to facilitate sales and command the highest prices they can in today’s weary commercial-property market.

Across the industry, big asset managers are casting around for financial tactics to grease deals and drum up cash after a rapid rise in interest rates have pressured returns. 

This is the only instance of seller financing in BREIT’s history. In these deals, it becomes a lender of sorts, forfeiting the right to be paid upfront in full. These financings — more typically used for struggling assets — also tend to make it easier for buyers to raise bids.

The company has signaled it’s readying for a potential inflection point — President Jon Gray has said real estate values are “bottoming.” Seizing on fast-growing sectors was key to how Blackstone built its reputation in real estate, and the firm has been eager to have its massive REIT find ways to capitalize on one of the worst real estate markets in more than a decade.

Balancing Act

The task has become even more difficult as high borrowing costs and plunging property valuations have dimmed investors’ view of real estate. BREIT sold itself on being able to give investors the ability to withdraw cash within limits. But redemption requests have consistently exceeded what it’s taking in each quarter since the end of 2022 and the company allowed investors to withdraw more than its monthly limits in May. 

Blackstone called the KKR transaction a win for BREIT investors, and noted that the firm received several offers above its marks even without the seller financing.

“Selling real estate at great prices is entirely consistent with delivering strong performance,” Blackstone said in an emailed statement.

BREIT sold $20 billion of real estate at a premium to its marks since 2022, and a majority of those deals did not have in-place transferable debt, according to the statement.

“Blackstone had in place a smart capital structure on this portfolio, which benefitted both sides and enabled us to reach a win-win outcome,” a KKR spokesperson said in an emailed statement. 

Tough Market

Investors in the REITs have been jittery ever since borrowing costs started rising. BREIT capped withdrawals for 15 months and finally let investors draw money without constraints in February. But a major rival, Starwood Real Estate Income Trust, last month tightened its redemption limits further, with billionaire Barry Sternlicht vowing investors would be better off in the long run.

Such a tactic to control liquidity risks stoking panic. For REITs like Blackstone that may have assets that are in demand, such as student housing, there’s a way to get cash from sales even in today’s tough market. That’s where financial maneuvers like seller financing can come in.

Previously used to offload the worst-hit properties such as offices, seller financing is now becoming a common tactic to grease transactions.

With seller financing, “you can make a deal work that otherwise seems to be stalled or seems to be undoable,” said Nicole Schmidt, managing partner of investment bank Oberon Securities. “It’s to help facilitate getting deals done, and getting them done much quicker.”

But there are drawbacks. Blackstone is losing the opportunity for BREIT to get all deal proceeds upfront. It’s also lending out money at lower rates than it could potentially generate from investing elsewhere. In the student dorm deal, BREIT is providing financing through preferred equity with an annual interest rate of 6.5% — less than what a bank would charge today, according to people familiar with the matter.

Blackstone weighed the cost of holding seller financing against the profits it stood to make for investors from the deal — about $500 million – and decided the gains were worth it.

“More and more of that below-market financing is being offered in the market to juice the last dollar of purchase price,” Josh Zegen, cofounder of Madison Realty Capital, said about different financing strategies coming to the market broadly. He declined to comment on BREIT. “What are the ramifications of that? Money isn’t coming back to the system and investors aren’t getting money back as quickly as they would have anticipated.”

Different Strategies

BREIT — which doesn’t trade on exchanges and can limit redemptions beyond certain thresholds — is closely watched for whether it will preserve its cash and valuations during one of the toughest times for real estate since 2008. The largest trust of its kind, BREIT has bet big on properties from data centers to warehouses and apartments.

But the trust has been dealing for months with redemption pressure. BREIT has also pivoted from a net buyer in 2022 to net seller in 2023 and secured a cash infusion from the University of California along the way. The firm said selling real estate in “lower growth” sectors gives it flexibility.

Other rivals have used different approaches to support their property trusts. KKR injected one of its major property trusts with $50 million of new capital and agreed to support its net asset value per share. The trust said it was aiming to convince investors to stick around as it starts to see a commercial-property recovery take hold.

Starwood’s move to further restrict redemptions from SREIT was a reminder that REITs of its kind can use different levers to control cash. The fallout from that decision extended to BREIT, where investors ramped up their requests to pull money. The Blackstone trust fulfilled all of the withdrawal requests in May, above the normal 2% limit. Blackstone said the board made the decision because of the fund’s liquidity and broad trend of falling redemptions.

Inside the firm, Blackstone executives have expressed concerns that enforcing the limits again would damage investor confidence, according to a person familiar with the matter who asked not to be identified citing private information. The firm also has been concerned people would assume that BREIT is in the same position as SREIT, people said.

Blackstone said BREIT’s structure is working as designed and the trust has no plans to change its share repurchase program. A spokesperson for Starwood didn’t respond to requests for comment.

Stepping Up Deals

Optics matter in the world of billion-dollar REITs aimed at retail investors, which are also offered by the likes of Brookfield Asset Management and Ares Management Corp. 

BREIT — which has $7.5 billion of immediate liquidity — has avoided drawing on a line of credit. The trust has also ramped up transactions to offload properties last year, boosting cash. Net sales proceeds more than doubled to $7.4 billion. New investments fell to a fraction of a percentage point of the prior year’s $35.9 billion.

Blackstone has paid attention to trades of BREIT shares on secondary exchanges. In the stretch BREIT had to enforce its withdrawal limits, it took four months on average for investors to get substantially all of the money they requested to pull. Some investors resorted to other ways to get out, even it meant paying a price.

When BREIT shares first started trading at a 15% discount on a startup platform called Lodas Markets in 2023, Blackstone executives relayed concerns to the firm. 

“They were genuinely concerned about the perception of how BREIT was valued,” said Lodas Chief Executive Officer Brian King.

Blackstone had previously broken a trade of BREIT, and then made clear it was limiting transfers to only its largest share class, he said.

During the year, when Lodas suggested ways to expedite the trades, Blackstone wanted to stick to a process of signing off on separate steps involved in the transfer. This effectively prevented faster settlement of trades for several BREIT share classes, King said. The platform settles such transactions for many other nontraded funds within days.

Despite having users willing to buy some $1 billion in BREIT shares, Lodas processed only $10 million of trades because of the process Blackstone put in place, said King.

Blackstone has stood by the argument it didn’t hinder trades, was adhering to standard procedures and allows shares to be traded, as long as they are converted to the largest share class. It said it “facilitated the onboarding” of a major share class and treated Lodas’ custodian as it did others.