Nontraded REIT math is still bedeviling

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 advisers and their clients.

The trickiness of the math comes right from the REITs themselves, nowhere else. Confusing fee structures, high commissions and unclear valuations have all troubled nontraded REITs in the past.

With the arrival of relative newcomers backed by Wall Street powerhouses, the $70 billion Blackstone Real Estate Income Trust Inc. and the $14.6 billion Starwood Real Estate Income Trust Inc., that bad math was supposed to be a thing of the past.

Both companies are so-called net asset value REITs, which were marketed and sold by wirehouses and registered investment advisers along with independent brokers, and were supposed to have fixed the opaque mathematics of the nontraded REIT industry. Both companies placed vigorous attention on updated valuations and providing greater amounts of liquidity to investors who wanted to redeem, or sell back, their shares to the REIT, according to industry players.

But analysts and executives have noted that with rising interest rates and fears of a recession hanging over the commercial real estate market, investors have been eager to get out of such REITs and redeem shares.

Indeed, this current market is triggering some tricky math for nontraded REITs and the financial advisers who sold them. And it's the bean counting behind the mathematical slicing and dicing of something called proration that could prove tormenting for the Blackstone and Starwood REITs.

On Dec. 1, Blackstone REIT told investors that redemptions had exceeded the monthly limit of 2% of its net asset value in October and 5% for the entire quarter, which pushed the company to prorate, or limit and portion, investor demands. That means some investors who wanted to get their money out of the fund were turned away — at least for now.

Then last week, a published report indicated that the Starwood REIT was also limiting client withdrawals.

Neither company responded to requests for fresh comment about the REITs. Blackstone’s CEO, Stephen Schwarzman, said this week at an industry conference that the majority of the REIT’s redemptions came from investors in Asia who had been hit hard by market swings, according to news reports.

It's how financial advisers and their clients respond to the proration of REIT share redemptions that is the important factor here. Will financial advisers who weren't looking to redeem client shares of Blackstone's REIT all of a sudden change their minds and jump in line, triggering further redemptions? How much anxiety are financial advisers who sold these REITs feeling right now?

According to the company, the Blackstone Real Estate Income Trust fulfilled the redemption requests in October about $1.8 billion, if full. But November was trickier, with the Blackstone REIT portioning client redemptions, with the company buying back about $1.3 billion. That was equal to its 2% of monthly NAV limit but approximately 43% of each investor’s repurchase request.

"It’s not that investors and advisers did not get liquidity from BREIT, it's that they didn’t get the entire amount," said one veteran nontraded REIT executive who spoke confidentially to InvestmentNews. "So this is not a total disaster."

"But historically when REITs and funds go into this proration, sales dry up," the executive said. "Who in their right mind will take that position with clients in a fund that has those liquidity problems?"

The key divide to watch is clients' redemptions of old shares versus new sales, the executive said.

"It's when the investors' request for redemption of their shares is greater than sales in a quarter, that's time to worry," the executive said. "As long as the REIT or fund is positive on the flow of capital, they don’t have to do much but tread water. If not, the question becomes, what does the company board decide to do? Shut down redemptions entirely, sell assets or increase leverage?"

When redeemed shares are being prorated, the executive said, financial advisers at times may also ask for a greater amount of shares to be repurchased because they are afraid they simply won’t get enough for their clients. "Redemptions in these situations have a tendency to go through the roof," he added.

Despite any recent improvements to nontraded REITs, the math that is the ultimate weight of gravity for such companies remains a potential torment for financial advisers.