The Lesson of Blackstone’s Retail Real Estate Fund: Liquidity Matters.

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The recent move by

Blackstone
’s
giant retail real estate fund to limit redemptions after outsize withdrawal requests is a wake-up call for investors in a once-hot sector that may now face more regulatory scrutiny.

Blackstone Real Estate Income Trust, known as BREIT, wasn’t supposed to offer surprises. The $69 billion BREIT, the leader among nontraded funds, was a way to get solid returns, a chunky 4% dividend, and the expertise of the world’s top commercial real estate investor. In return, investors sacrificed liquidity—they could only withdraw their investments from the fund, which doesn’t trade on an exchange, up to 2% of net-asset value a month and 5% a quarter. For quite a while, it worked; the fund returned 9% this year through October and 13% annually since its inception almost six years ago.

Those strong returns attracted $26 billion of net purchases from investors in 2021. But inflows turned to outflows, and on Dec. 1, Blackstone (ticker: BX) made a surprise announcement: It was limiting investor redemptions after requests hit the quarterly limit—what’s known as “gating” a fund. Redemption requests rose from $1.8 billion in October to $3 billion in November, forcing it to prorate and accept only 43% of requests, in order to limit total payments to 2%, or $1.3 billion. To stay within the 5% quarterly cap, BREIT will redeem just 0.3% of the fund in December, some $200 million.

With the fund now gated, redemptions are likely to continue, and inflows could be challenged, say Wall Street analysts. BMO analyst Rufus Hone wrote that he expects near-term inflows to “drop to essentially zero,” while Benjamin Budish of Barclays, in downgrading Blackstone stock to Equal Weight from Overweight, wrote that the caps could “drive further run-on-the-bank type redemption requests, as well as pressure new inflows, as advisors will be less likely to recommend a product that is (for the moment) limiting liquidity.”

That reversal of flows could be a problem for BREIT. Public REITs have permanent capital, but BREIT is dependent on investor flows. If withdrawals continue, the fund might have to sell assets bought in better days or add to its already sizable debt load, which totaled $68 billion at the end of September. BREIT has over $9 billion of liquidity, but most of that is credit lines and other borrowing vehicles. Available cash totaled $1.4 billion on Sept. 30. Earlier this month, BREIT announced the sale of a roughly 50% interest in two Las Vegas properties, MGM Grand and Mandalay Bay, which will result in proceeds of $1.3 billion in early 2023, and a gain.

Company / Ticker	Recent Price	YTD Total Return	3-Yr. Total Return **	Market Value (bil)	Debt (bil)
Blackstone Real Estate Income Trust*	$15.06	9.3%	15.8%	$69.0	$68
Prologis / PLD	117.08	-29.1	10.3	111.0	18
Mid-America Apt. Communities / MAA	163.40	-27.1	17.3	19.0	5.0
Vanguard Real Estate Index / VNQ	86.33	-23.9	4.2	35.2	NM

*Performance data through Oct. Debt as of Sept.30. **Annualized. NM=Not meaningful.

Sources: FactSet; company reports; Morningstar

“This is an important test case for the industry and an enlightening moment for financial advisors and investors,” says Credit Suisse analyst Bill Katz. “It all works well in a bull market when NAVs are going higher, but when you get into a more volatile environment and investors want to redeem and can’t, it may change behavior for everyone.” He wrote that regulators may take a closer look at nontraded funds due to investor liquidity issues.

Katz projects that BREIT will be at its quarterly redemption limit of 5% through the third quarter of 2023. There is incentive for investors to redeem because BREIT is up 9% this year while comparable public REITs are down about 30%.

Blackstone defends BREIT and its structure. In a CNBC interview on Thursday, Jon Gray, Blackstone’s president, said it’s “so important” that BREIT limit liquidity to protect the fund’s investor base. In a statement, the firm said, “Our business is built on performance, not fund flows, and performance is rock solid. BREIT has delivered extraordinary returns to investors since inception nearly six years ago and is well positioned for the future, given its concentration in rental housing and logistics in the Sunbelt and its long-term fixed-rate debt structure.”

That performance comes at a high cost. BREIT has two fees: an annual management fee of 1.25% of net assets and an incentive fee of 12.5% if the annual total return is 5% or higher. These fees totaled $1.4 billion so far this year.

The management and incentive fees have been paid in stock, not cash. That’s reflected in BREIT’s calculation of net income, as required by generally accepted accounting principles. The high fees—plus elevated depreciation—are key reasons that BREIT has operated at a loss on a GAAP basis so far in 2022 and in recent years. But based on its financials, BREIT doesn’t reflect the fees in a key REIT cash-flow measure, funds available for distribution, or FAD, which is derived from adjusted funds from operations, or AFFO, another REIT cash-flow measure.

That has implications for BREIT’s outsize, tax-advantaged distribution, or dividend yield, of 4%. The fund paid $2 billion in dividends in the first nine months of 2022, while FAD was $1.5 billion. Include management and incentive fees and FAD would be close to zero. BREIT prefers to focus on cash flow from operations, and based on that measure, it covers the distribution. But cash flow from operations excludes management and incentive fees, as well as a provision for maintenance capital on BREIT properties. This contrasts with comparable companies such as

Prologis

(PLD), the leading warehouse REIT, and

Equity Residential

(EQR) and

Mid-America Apartment Communities

(MAA), two top apartment REITs, which comfortably cover dividends from AFFO.

“AFFO and FAD are non-GAAP metrics and do not impact investor returns,” Blackstone said in a statement. “BREIT covers distributions from cash flow from operations, which is a GAAP metric. The total return is the total return—it reflects BREIT’s net asset value and the mix of cash flow and appreciation.”

Investors may want to opt for comparable public REITs like Mid-America or Prologis. Investors can take advantage of the selloff in their stock prices and their lower leverage than BREIT. “I don’t see the benefit of giving up liquidity in a private structure,” says Charles Lieberman, chief investment officer of Advisors Capital Management. Investors might not, either.

Write to Andrew Bary at [email protected]