Top executives at Blackstone declared themselves baffled that so many retail investors want their money back from its giant private property fund, given its strong performance.
They shouldn’t be surprised. The very design of the fund encourages investors to withdraw when they see others doing so. My worry is, those same incentives could hit other parts of the financial system as central banks pull back from easy money.
A slow-motion dash for cash is under way across the whole of finance as the Federal Reserve sucks liquidity out of the system. Most harmed will be those who piled into private assets without thinking about how much cash they might need.
The basic principle of the Blackstone Real Estate Income Trust, or BREIT, is that it took $46bn from ordinary investors, added debt and bought a bunch of property, mostly Sunbelt housing and warehouses. It was good at it, or perhaps lucky, and the value of the fund went up a lot, so it was very popular.
But this year mortgage rates soared and recession fears rose, and house prices began to come down. They have dropped only a bit so far, and not everywhere, but enough to make it less obvious to investors that they ought to be piling cash into a leveraged bet on property prices.
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Blackstone isn’t dumb, and it thought in advance about the possibility that one day people would want their money back. The contracts limit withdrawals from BREIT to 2% of the fund each month, or 5% a quarter, to avoid the need for fire-sales of property. Now people want some of their money back, and the limits have kicked in.
The problem is that investors in BREIT now know that other investors in BREIT (and a similar fund, from Starwood Capital Group, known as SREIT) are trying to withdraw. Just as with a bank run, an investor who thinks others will try to withdraw should get out first. Even those who think everything will soon calm down — and there are reasons to think it might — should still be concerned about the effects of others leaving.
It isn’t just BREIT. Private credit funds became wildly popular over the past decade and mutual funds bought into private equity, part of increasingly creative attempts to make money in a world of zero interest rates. Some, which hold hard-to-trade assets and allow withdrawals, are also vulnerable to self-fulfilling fears about liquidity.
I see four areas of vulnerability in BREIT that could apply to other funds.
- Anyone who thinks they might need to cash in over the next year will withdraw earlier than planned. Investors who tried to pull out in November got only 43% of what they asked for, and in December the cap will limit withdrawals far more. The longer the cap is in place, the more people will need to join in.
- Investors can buy much more cheaply in public markets. REITs listed on the stock market trade at a fat discount to the value of their holdings. Investors happy to hold REITs managed by others could sell BREIT at the still-elevated estimated value of its holdings, and buy a listed REIT at less than the estimated value of its holdings.
- BREIT borrows about $1 for every $1 of investor value, but as investors pull out, the proportion of its holdings financed by loans goes up. That’s great when prices rise — one of the big reasons for investing in property is that it can use a lot of leverage — but if prices go down, more leverage amplifies losses.
- Withdrawals make the fund less liquid. BREIT sits on $9.3bn of cash and bank facilities, so it won’t have any problem repaying the investors who have asked to get out, and it is a long way from liquidity trouble. But if withdrawals continue, those who remain will be holding a fund with less and less cash, giving it less flexibility to snap up bargains in the markets or to satisfy future withdrawals.
The third and fourth problems can be delayed by Blackstone selling buildings, as it just did with its stake in the MGM Grand and Mandalay Bay casinos in Las Vegas, or converting the billions of dollars of other easy-to-sell assets into cash. Delay long enough and investors’ concern may abate.
Hedge funds discovered all these problems in 2008, when clients rushed for the exits. Their ventures into unlisted assets — often pre-IPO stocks, but some funds bought assets as exotic as African farmland and art — left many investors holding hastily-created “side pockets” full of unsalable stuff from their funds. Others simply refused to allow withdrawals, to avoid penalising investors who remained.
Blackstone says withdrawals from BREIT have come primarily from overseas investors, particularly in Asia, who chairman and chief executive Stephen Schwarzman suggested were hit by margin calls when Hong Kong stocks plunged. These are exactly the sort of people one doesn’t want to invest alongside, because they will become forced sellers when markets are falling.
Ultimately it is a confidence game. If you think others have lost faith, it makes sense to pull out too. This is why Blackstone is going out of its way to point out all the good things about BREIT — which this year includes a cool $5.1bn made on interest-rate derivatives.
“Our business is built on performance, not fund flows, and performance is rock solid,” Blackstone said.
The problem Blackstone and its peers have is that in a world increasingly demanding liquidity, it is selling illiquidity.
Write to James Mackintosh at firstname.lastname@example.org
This article was published by The Wall Street Journal, a fellow Dow Jones Group title