Another trough coming in 2024 for boom-and-bust non-traded REITs

Non-traded real estate investment trusts face a well-documented set of challenges, including sharply rising interest rates and headlines about half-empty office buildings.

2024 looks to be another tough year for sales of non-traded real estate investment trusts, a product that has a history of booms and busts and now appears to be heading for a trough.

Non-traded REITs are public companies but aren’t registered on any public exchanges and don’t trade. As InvestmentNews reported in November, sales of non-traded REITs tanked last year, with the industry raising just $9 billion through September after successive years in which it took in more than $30 billion in new capital. The last few months of 2023 likely saw sales barely budge.

The reasons for the slump in REIT sales last year are well documented. The industry is facing a series of negatives: sharply rising interest rates, headlines about half-empty office buildings, and investors pulling their money from products, most notably the industry’s biggest player, the $61 billion Blackstone Real Estate Income Trust.

Meanwhile, more than $2.2 trillion in commercial real estate debt is coming due before 2028, The Wall Street Journal reported this month. Much of that will have to be refinanced at higher rates, and some real estate investors could default.

Other concerns for real estate investors include the potentially volatile politics of a presidential election year and questions about whether REITs in general can continue to kick off their distributions, or dividends, to mom-and-pop investors who rely on the products for income.

FALLOUT COMING

Investors are anticipating trouble in real estate loans and fallout for the rest of the market.

“Real estate equity REITs are gonna be in trouble,” Howard Lutnick, Cantor Fitzgerald chairman and CEO, said in an interview with Fox Business this month. “A lot of them are gonna get wiped out. I think $700 billion could default.

“There’s going to be selling,” Lutnick said. “There’s a generational change in real estate coming. The end of ’24 and all of ’25, we will talk about all of real estate being in a massive change, with $700 billion to $1 trillion in defaults coming. I think it’s going to be a very, very ugly market owning real estate over the next 18 months to two years.”

But Brad Thomas, CEO of Wide Moat Research, sees some reasons for optimism.

“The debt maturities are a serious issue, but the large, publicly traded REITs, as opposed to their non-traded counterparts, could benefit because they have investment-grade balance sheets,” said Thomas, a long-time analyst of real estate investing. “That means they should be able to buy some high-quality properties because the smaller developers won’t be able to hang onto them.

“Real estate financing is hard right now as the banks are being selective, and you can’t ignore the significant amount of commercial real estate debt coming due,” he added.

MORTGAGES COMING DUE

“What’s going to happen over the next couple of years when commercial mortgages come due, and who will pick up the pieces?” asked a senior industry executive, who asked not to be identified. “Where will they get their refinancing, and where will the REITs and real estate investors go to get their leverage?

“Right now, the firms that hold a bunch of those loans are the regional banks,” the executive said. “And those smaller banks can’t do it, especially after what happened last year. They won’t be able to refinance.”

As noted above, 2023 was an awful year for sales of non-traded REITs, and this year is shaping up to be no better. It shouldn’t come as a surprise as the industry has been plagued by boom-and-bust cycles for the past 20 years.

The pitch for non-traded REITs, past or present, has always been simple: They’re a way for clients to diversify their portfolios, invest in commercial real estate, and reap steady yields.

But some REITs had issues that were brought to light in large part by the real estate and credit crisis of 2008 – shutting off redemptions, unclear valuations, high fees, a lack of liquidity, and not generating enough revenue to cover monthly and quarterly distributions. Sales plummeted.

ENTER NICHOLAS SCHORSCH

Jump forward to 2016. The industry had rebounded with the entrance of Nicholas Schorsch and his firm, American Realty Capital, but again hit the skids when non-traded REITs faced criticism about excessive commissions amid new industry rules that made fees and pricing more transparent.

Contributing to the sales slowdown was Schorsch, who faced an accounting scandal that would end with his firm’s former chief financial officer being found guilty of federal securities fraud and related charges and, separately, a settlement with the Securities and Exchange Commission entailing $60 million in penalties.

The industry remade itself again, focusing on selling so-called net asset value REITs that made it easier for clients to sell shares back to the company and cash out. Sales soared. But in 2023 investors sought to get out of NAV REITs, with total net sales, which includes redemptions, of almost negative $4 billion, according to industry sources.

That has led some big firms, including Blackstone, to pivot to new alternative investment products other than real estate and REITs, industry executives noted.

In January, Blackstone said a new fund for wealthy clients that focuses on private equity, Blackstone Private Equity Strategies Fund, had raised $1.3 billion, a staggering amount for a new fund.

“We’ve seen this move before,” said the industry executive who asked to speak privately. “REITs are struggling with sales, so the product sponsors look around and say, ‘Private equity is hot right now, so let’s jump into that.’”