This column for years has been writing about the bedeviling, bewitching math behind nontraded real estate investment trusts and other illiquid investment products that financial advisors sell to their clients.
Such products are difficult to understand because they don't trade every day on an exchange but instead often rely on internally hired appraisal teams to determine a value at the end of the month. They also often come with high or complex fees and commissions that benefit the product manager and the brokers who sell for them.
Investors' recent rush to pull billions in cash from the illiquid $59 billion Blackstone Real Estate Income Trust Inc. - or BREIT - is the latest event in a 20-year history of retail nontraded REITs that underscores the need to question what these products are actually worth and who should buy them.
Valuations for nontraded REITs in the past, particularly during and after the 2008 credit crisis, have been so embarrassingly bad the Financial Industry Regulatory Authority Inc. in 2016 actually changed industry rules so clients had a truer picture on their account statements of what an illiquid REIT may actually be worth. Until then, many nontraded REIT prices valuations had been frozen for years at $10 per share, the price at which they were sold, regardless of the ups and downs of the real estate markets.
A number of REIT executives for years defended the $10 per share valuation method, often citing the fact that their or their friends' grandmothers didn't like seeing investments jump up and down on account statements. Such swings made the old ladies nervous.
In the second half of 2022, the questions about nontraded REIT valuations returned. Investors were increasingly fearful of rising interest rates and the falling commercial real estate market, and BREIT and other real estate funds said they temporarily turned away some clients who wanted to pull money from their funds.
As I noted in writing about BREIT in December 2022, "The math behind nontraded real estate investment trusts has always been vexing. That’s why this product needs to be regarded with the utmost caution by financial advisors and their clients."
Fast forward to spring 2024. Investors have pulled more than $15 billion from BREIT. And the company's net asset value does not appear to be feeling the woes of the broad downturn in commercial real estate.
Just as interest rates began to rise, BREIT reported an NAV of $14.53 per share in January 2022. That increased eight cents per share by last October, the same period over which the S&P U.S. REIT Index declined 35%. The REIT's valuation was $14.15 per share in February, according to the company,
"Our process requires us to use monthly property valuations that have been assured by a third-party; we have never overridden these in BREIT’s history," a Blackstone spokesperson wrote in an email. "We stand by our rigorous valuation process, which is virtually identical to the one we use for our open-ended, institutional vehicles and has been validated by $20 billion of assets sold at a premium to NAV since 2022."
But two prominent media outlets, The New York Times and Business Insider, are paying attention to BREIT. Both, coincidentally enough, this week published strong critiques of BREIT, focusing on its valuation as well as long-term sustainability.
"On Wall Street, one mystery has been whispered about for months: How accurate is the valuation of Blackstone’s flagship real estate fund," wrote Andrew Ross Sorkin and a team of reporters in Tuesday's Times.
"The speculation has arisen because the fund, the $59 billion Blackstone Real Estate Income Trust — more commonly known as BREIT - has managed to keep an 'appraised' value of its assets that far exceeds virtually every other real estate fund," Sorkin and team noted. "Many rivals have fallen in value, some quite dramatically, in the face of high interest rates and a flagging property market."
At Business Insider, Bethany McLean on Tuesday wrote: "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," McLean added.
"It's hard to believe that it was a coincidence both the Times and Business Inside posted these probing pieces about BREIT on the same day," said one industry executive, speaking privately to InvestmentNews.
The conclusion? Sketchy math dogs private market investments sold to retail investors. And dogs like that often don't frolic or hunt; they sit around and scratch for fleas.
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