The wave of capital flowing into non-traded REITs in recent years has made a dramatic reversal. A surge in redemption requests has resulted in a staggering $12.2 billion in capital outflows back to investors in recent months. And there is likely to be more pain ahead in the coming year as the sector lowers net asset values (NAVs) to reflect evolving market conditions.
But industry backers also argue that the sector is well-positioned to handle the uptick in redemption requests and is better structured than in past economic cycles.
Blackstone, which captured the dominant share of fundraising in recent years, is now on the hot seat with the biggest load of redemption requests. Blackstone Real Estate Income Trust (BREIT) paid out $9.9 billion in redemption requests in 2022–15.2 percent of the REIT’s total NAV, according to data from Robert A. Stanger & Company. Blackstone CEO Stephen Schwarzman has said that a large portion of the redemption requests have come from Asian investors who have sought liquidity for reasons not related to the REIT’s performance. However, those Asian investors created a “snowball effect” of investors that were lining up to take money out ahead of what many anticipate will be lower values or NAV ahead.
These requests have exceeded the monthly and quarterly caps most non-traded REITs have in place on redemptions—typically in the range of 2 percent of outstanding NAV per month and up to 5 percent per quarter.
“I think that will turn later this year after the NAVs are brought down to a level that makes a little bit more sense relative to what is going on in the real estate universe given the increase in interest rates,” says Kevin Gannon, chairman and CEO of Robert A. Stanger & Company.
Gannon expects redemption requests to remain elevated through the first half of 2023 and probably through the end of the year. However, the impact has been uneven among the major non-traded REIT players. While Starwood and KKR, along with Blackstone, have hit their caps on redemption requests, other REITs have been less affected. Nuveen Global Cities REIT paid out $25 million in 2022, which is the equivalent of 1.3 percent of NAV, while Hines Global Income Trust reported $47 million in redemption requests, or 2.1 percent of NAV last year, according to Stanger.
“Redemption requests have been around for a long time, but because it happened to the 800-pound gorilla in such a short amount of time, that is what has caused all of these ripple effects and shock waves through the industry,” says David Auerbach, managing director of Armada ETF Advisors, which operates a public REIT ETF.
Although Blackstone has shouldered a big share of redemption requests, it remains to be seen if it will trigger a bigger wave that spreads across the non-traded REIT sector. “A lot of this will rest on the information and perspective that is given to individual investors by their financial advisors,” says James Sprow, senior vice president, research at Blue Vault Partners, a research firm which tracks alternative investments including non-traded REITs, BDCs, closed-end funds, interval funds and private offerings. Financial advisors should be educating their clients on the long-term nature of these investments with limitations on redemptions that are in place to protect investors from forced asset sales that can harm portfolio values and returns for investors, Sprow adds.
Investors are wary of declining values
Blackstone, and the broader non-traded REIT sector, appear to be holding up relatively well to pressure from redemption requests. Despite paying out 15.2 percent of its NAV in redemption requests last year, BREIT generated $19.4 billion in new fundraising and another $1.4 billion in direct reinvestment (DRIP) for a net gain of $10.9 billion, according to Stanger.
Data shows that gross fundraising for the non-traded REIT sector reached $33.3 billion last year, which is down only slightly from the record high of $34.4 billion in 2021. However, fundraising was clearly decelerating later in the year with the $3.6 billion in capital raised during the fourth quarter that was on par with the one-month total in January 2022. Fundraising is declining and redemptions are increasing, in large part because people are concerned about NAVs coming down.
Publicly-traded REIT total returns dropped about 25 percent in 2022. Non-traded REITs have not logged a decline to that extent. Many observers believe there will eventually be a convergence in valuations given that the underlying assets for both sectors remain similar.
Non-traded REITs are now starting to lower their NAVs, although individual adjustments vary widely. For example, Blackstone lowered its NAV by 4.0 percent in 2022, Brookfield Real Estate Income Trust lowered its NAV by 7.0 percent; Cantor Fitzgerald Income Trust by 4.4 percent and Starwood Real Estate Income Trust 1.5 percent, according to Stanger.
For those investors that may be looking to redeem shares ahead of major repricing, there also is a good argument that portfolio values could hold up better than expected because of the cash flows they’re generating, notes Sprow. NAVs in private REITs tend to be based on discounted cash flow methodology. Interest rate increases flow into the discount rates that REITs are using to value cash flows from properties and ultimately impact NAV.
“I think a lot of the negative impacts on the aggregate NAVs on these continuously offered REITs can be explained by interest rates rather than any drastic fall in the value of their portfolios from other causes,” says Sprow. For example, Blackstone has the bulk of its portfolio invested in industrial and rental housing, and there is a valid case that the cash flows from these properties are very secure, he adds.
REITs hold up under liquidity pressure
Redemption requests are creating a real-time stress test for the new generation of non-traded REITs. In legacy lifecycle non-traded REITs, investors relied on share purchase plans for liquidity, which provided liquidity for about two to three percent of outstanding shares outside of an external liquidity event, such as a sale or IPO. The new generation of perpetual NAV REITs are designed with an element of liquidity built in to fulfill redemption requests. Those redemption requests are bracketed by up to 2 percent of outstanding NAV per month and up to 5 percent per quarter.
“The new generation of non-traded REITs was intentionally designed with these types of redemption caps to protect all investors in the fund, while still allowing for liquidity for investors that want it,” says Anya Coverman, president and CEO of the Institute for Portfolio Alternatives. “This has been a market test for the new non-traded REITs from a liquidity perspective, and one that funds have certainly passed. We haven’t seen any forced selling of assets and don’t expect to at this time.”
It’s also important to note that there has been no gating in the industry. No fund has had to gate or suspend redemptions, rather a few have prorated requests within the relevant period, as fully disclosed in the prospectus, adds Coverman.
In order to provide liquidity for redemption requests, NAV REITS are built with liquidity sleeves and capital that is invested in more liquid securities that they can tap into so they don’t have to resort to selling real estate assets in a down market. “NAV REITs might not like to give up that equity, but they are positioned to do it, which is what they said they were going to do,” says Gannon. Gannon believes that REIT liquidity sleeves are sufficient to carry REITs through 2023 and possibly into 2024 without having to liquidate assets. If fundraising can maintain the $1 billion monthly pace that it saw at the end of 2022, that alone would cover a big chunk of redemptions.
Weathering the storm
Blackstone’s recent deal with the University of California was a way for the firm to bolster its liquidity sleeve in BREIT. In exchange for a $4 billion investment, Blackstone is guaranteeing an 11.25 percent return and putting up $1 billion of its own stock in BREIT as collateral. Blackstone is effectively putting its money where its mouth is in backing up the NAV and the return to the University of California, notes Gannon. That also shows how these large players are better equipped to handle market challenges with innovative solutions. “Fundamentally what has happened in this space over the last several years is that we now have these big names at the table with Blackstone, Starwood, Nuveen, Ares, Apollo, Cantor Fitzgerald and others. These are not bootstrap sponsors trying to raise money,” says Gannon.
It remains to be seen whether redemption requests will tarnish the image of non-traded REITs and take the edge off the appetite of both investors and the RIA and broker-dealers that have been recommending these products to their clients. Volatility is significantly lower in non-traded REITs. So, there is a strong argument that these continuously offered non-traded REITs with their limits on redemptions are still protecting investors the way they were designed to do. “When you compare the volatility of these NAVs per share compared to the volatility of the public REIT sector, there’s no comparison,” says Sprow. “The risk return equation that you look for in real estate assets is so much more favorable over the last couple of years for the non-traded REIT sector than the listed REIT sector.”
Some view the recent redemption requests as a case study unfolding in real time. Will it change structures in terms of how redemption requests are handled, where caps are set or how liquidity sleeves are structured? “I feel like this is a learning curve that we are in the middle of right now,” says Auerbach. “The private REITs are here to stay, but I also think that how these companies weather the storm and handle these redemption requests could be a game changer going forward into the future.”