Private REITS were a hot investment trend, but they’ve lost some appeal

The process of getting out might not be so easy. It might not be easy to get out.

Private equity firms started looking for smaller investors more than a decade ago. The big fund managers also used it to grow their assets and earn ever-larger fees. But it was also a way for the big fund managers to grow their assets and rake in ever larger fees.

For the individual investors, who were directed to the new private funds by their wealth managers, the chance to invest with Wall Street’s elite was too good to pass up — even if it came with rules, like limits on withdrawals that would mean that getting money back in tough times might be a challenge.

The private equity firms had an allure, created by stellar track records, including during the 2008 financial crisis, and the fact that they had been off limits to ordinary (although wealthy) investors. One offering in particular captured peoples’ attention: private real-estate investment trusts, known as REITs, which own commercial or industrial properties and pay big dividends off the rental income they generate.

From 2017, when Blackstone introduced one of the first REITs backed by a private equity firm, through June, the two dozen or so of these private REITs raised more than $110 billion from investors, making them one of the hottest so-called alternative investments. The REITs were especially attractive when interest rates were close to zero because they paid dividends that were up to 4 percent or more of assets. Even the lowest-risk bond investments pay close to 4 percent now, and rising interest rate have hammered commercial property markets that many REITs invest in. How are they able to show investors high returns while publicly traded competitors have suffered losses. How can they pay out such lucrative dividends if they aren’t generating as much revenue each quarter as what they’re returning to investors? What’s their rationale for saying the properties they own are holding their value, when in public markets commercial real estate prices are tumbling?

There are more than 100 REITs that trade on public stock exchanges. It’s easy to sell shares in a REIT controlled by a private firm. But when it comes down to a REIT controlled by a fund, the fund must buy back investor shares. To make sure their investments remain stable and keep from being forced to sell properties in shaky markets to repay investors, most limit how much investors can withdraw in any given month or quarter.

Private equity firms do the same sort of thing to their big investors, typically preventing withdrawals for at least five years. Private REITs limit withdrawals to 5 percent of assets per quarter for smaller investors. In May, one of the larger private REITs managed by Starwood, the real estate and investment firm owned by billionaire Barry Sternlicht, increased the limits on how much investors can redeem. Starwood announced it would only purchase 1 percent of the fund’s value every quarter. This is down from the previous 5 percent. The REIT stated that it did not have the cash to cover all withdrawals, and it didn’t want investors to be forced to sell properties in a slow real estate market. It wasn’t the first time this had happened: In late 2022 and early 2023, Starwood, Blackstone and KKR each tightened the existing limits on redemptions, but after a few quarters, the firms eventually gave investors back all the money they asked for.

Even so, Starwood’s recent decision spooked investors, and since May, redemption requests have spiked at Starwood’s competitors too, according to public filings and an analysis by Robert A. Stanger & Company, an investment bank that follows alternative investments.

New filings due out later this month should shed more light on the situation, but the increase in investors asking for money back raised questions about the future of non-traded REITs. Kevin Gannon, the chief executive of Robert A. Stanger, predicts that half of the money raised from non-traded REITs will be redeemed in the next year. Kevin Gannon, the chief executive of Robert A. Stanger, predicts that half of the money raised from non-traded REITs will be redeemed in the next year.

Some investor exits are because of concerns that the REITs may have to knock down the value of their investments.

One key metric for REIT investors is net asset value, which is the value of the real estate in a portfolio after deducting the debt used to pay for the properties.

For publicly traded REITs, the net asset value dropped roughly 14 percent from the end of 2021 to June 30, according to Robert A. Stanger. During the same period, the net value of real estate in REITs backed by private equity firms fell by just 4 percent.

Stock prices also show a large drop in value in the public market. The FTSE Nareit Index, a REIT index, has fallen 22 percent between the end of 2020 and early August. Shares of the largest REIT exchange-traded funds, including funds managed by Vanguard and iShares, are down 15 percent or more in that period.

Blackstone, meanwhile, has returned 4.1 percent on an annualized basis since the end of 2021, the fund said.

Since private REITs don’t trade on an exchange, their performance is determined by appraisals of the value of their real estate. In bulletins intended to educate investors on REITs, the Securities and Exchange Commission warned that these appraisals may not be accurate or timely. Bak is the CEO of a firm which invests in REITs and public exchange-traded fund on behalf investors. He has been critical of private REITs because he believes they are not being transparent enough. He said that in any scenario, non-traded private REITs’ returns will be reduced because they have borrowed from future returns, by not marking down their assets when the asset class has declined. The fund managers have rebuttals. On a recent earnings conference, the chief executive at Blackstone, who runs the largest private REIT, said the fund’s warehouses, rental housing, and data centers portfolio, rather than the malls and offices, explained the fund’s performance. Blackstone says that its fund, Blackstone Real Estate Income Trust has sold $26 billion worth of its $125 million property portfolio since the beginning 2022 at prices higher than what they were marked.

But, the market for commercial real estate is not transparent. Investors can’t easily track the changes in prices, unlike in the housing market, where it’s easier to do so. The firm reported that redemption requests in July were the lowest since April 2022.

One of the reasons Blackstone was able to do this is because it struck a deal with UC Investments, the investment arm of the University of California. UC Investments announced in January 2023 that it had invested approximately $4.5 billion into the fund and promised to remain in it for six more years. Investors have discovered another concern with Blackstone’s REIT. Investors and analysts have questioned how Blackstone can pay out more in dividends than it generates by certain measures of its cash flow. In interviews with a half dozen of these analysts and investors, many questioned how Blackstone can pay out more in dividends than it generates by certain measures of its cash flow.

“How sustainable is it to keep paying that amount of dividends if the underlying cash flows are so low relative to the amount they’re paying?” Ms. Steiner asked.

Jeffrey Kauth, a Blackstone spokesman, said in an email that about half of the fund’s REIT investors choose to take their dividends in shares, not cash, so the REIT generates positive cash flow in excess of the cash dividends. He said that if REITs were unable to cover the cash dividends they would have to change the way they report their monthly real estate net assets values. He wrote that it would not affect investor returns.

In July, KKR announced a goal to keep the net asset value of each share at or above $25. KKR announced that if the value fell below this level, it would sell its shares in the fund. Lower rates could push REIT valuations higher. Lower rates could drive REIT valuations higher. To him, that’s the point of the withdrawal restrictions.

“These products have worked as intended,” Mr. Siegenthaler said.

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