Investment analysis tends to be only as good as the expertise of its sources. Regarding commercial real estate, some of the biggest misconceptions held by people outside the industry include the assumption that all commercial properties are created equal and that office buildings make up the bulk of the commercial real estate sector. (In reality, offices are about 15% of the market). Over the past two years, this has led to panicked headlines about the crisis in commercial real estate, while in reality, the distress has been concentrated mainly in the office sector. In the latest spin on this genre, The New York Times ran a story earlier this week that questioned portfolio valuations of Blackstone’s non-traded REIT BREIT. Other outlets picked up the news, running headlines that included “Inside the Growing Alarm Over Blackstone’s BREIT Real Estate Fund” and “Veteran Analysts Say the World’s Biggest Private Equity Firm Could Be In Big Trouble.”
The New York Times article focused primarily on how Blackstone comes up with valuations for BREIT, given that the discounts it posted over the past few years have been minimal compared to over 14% decline in NAVs for publicly-traded REITs between 2022 and today, according to consensus analyst estimates. The authors zeroed in on the fact that while BREIT uses a third-party appraiser and an independent auditor to appraise its properties, the final valuation is determined after its own advisor reviews it. Blackstone published an update to its stockholders this week that included a section addressing its valuation process. It highlighted that its valuation process and disclosures adhere to guidance from the SEC, FINRA and Institute for Portfolio Alternatives. In addition, "We believe there is no better affirmation of the rigor of our valuations than the fact that in the last two years BREIT has sold $20B of assets at an average 4% premium to carrying values, generating over $4B of profit for our investors."
"Our process requires us to use monthly property valuations that have been assured by a third-party; we have never overridden these in BREIT’s history," a Blackstone spokesperson said. "We stand by our rigorous valuation process, which is virtually identical to the one we use for our open-ended, institutional vehicles and has been validated by $20 billion of assets sold at a premium to NAV since 2022."
However, according to Luke Schmidt, senior financial analyst with management consulting firm Blue Vault Partners, BREIT is not the only non-traded REIT that uses that approach. For example, the Starwood REIT (SREIT) prospectus contains the same language about retaining the authority to override third-party valuations as BREIT’s, Schmidt noted.
In fact, BREIT’s property valuations might be incorporating higher discounts compared to its peers in the non-traded REIT space, he said. For example, while BREIT uses a 7.2% cap rate for its multifamily properties, JLL Income Property Trust uses a cap rate of 7.0% and SREIT a cap rate of 6.8%. Meanwhile, while BREIT uses a cap rate of 7.5% for its industrial properties, SREIT, JLL Income Property Trust and Ares Industrial REIT, all estimate the cap rate as averaging 7.2%.
In its recent note to shareholders, BREIT noted that it “widened assumed exit cap rates in its core sectors of rental housing and industrial by +18% and discount rates by +13% (in each case, reducing asset values) since December 2021. ... We believe BREIT’s valuation assumptions were adjusted more quickly and are more conservative than non-listed REIT peers.”
While it might make sense to examine BREIT’s valuation methods more closely, “to say something is truly wrong might be a stretch,” Schmidt wrote in an email.
“I don’t see a real issue in how they are valuing these properties,” he added. “BREIT is also the most diversified REIT in the industry just due to how big it is compared to all the others. The other funds that are more specialized, or less diversified, are naturally going to see more drastic changes in their values if those particular sectors are impacted one way or another.”
Similarly, Kevin T. Gannon, chairman and CEO of investment banking firm Robert A. Stanger & Company Inc., noted that the cap rates BREIT disclosed for each asset class it owns fall within the range of valuations published in survey data used by commercial real estate professionals. For example, in March, cap rates on closed transactions involving multifamily properties averaged 5.4%, according to research firm MSCI Real Assets, indicating significantly higher valuations than those listed by BREIT. Cap rates on transactions involving industrial properties averaged 6.1%.
“We can’t say they priced it incorrectly,” Gannon said. “They do seem to fall within market parameters.”
In addition, BREIT’s portfolio carries a high concentration of properties in high-growth sectors, he noted.
Eighty-seven percent of BREIT’s properties are distributed across three sectors: multifamily rentals (including apartment buildings, student housing, single-family rentals and affordable housing), industrial and data centers. The remainder is split between net lease assets (5%), office (3%), hospitality and retail (both 2%) and self-storage (1%). The portfolio currently has an occupancy rate of 95%. It has a leverage ratio of 49%, with 86% of its financing coming from fixed-rate loans and the remaining 14% from floating-rate debt. Year-to-date, BREIT posted a total net return of 1.8%, including 0.6% in March.
While industry insiders expect apartment rentals and industrial properties to experience short-term drops in demand because of the outsized volume of new construction coming on the market over the next year, there are few concerns about their long-term performance prospects. Over the year ending in March, the industrial property price index tracked by MSCI Real Assets posted an increase of 5.7%. Apartment properties fared worse, with a drop of 8.4%, but prices on apartment buildings remained 11% above their pre-pandemic level, MSCI researchers wrote.
Industrial and apartment properties also accounted for the lowest volumes of distress, including bankruptcies, loan defaults and court administrations, in the commercial real estate universe in the first quarter. Out of $88.6 billion in distressed situations, industrial assets accounted for slightly over $1.6 billion and apartment buildings for $9.9 billion, MSCI Real Assets reported.
According to a recent Seeking Alpha note on private REITs authored by Brad Thomas and Christopher Volk, BREITs’ is a “large, diverse portfolio broadly centered in Sunbelt states with 85% of the rents derived from… three sectors prized for their reliability that unsurprisingly also rank among the most highly valued in the publicly-traded REIT space.”
One of the questions The New York Times posed about BREIT’s strategy asked why it has not disposed of significant amounts of apartment or industrial properties recently. However, property owners not experiencing distress or an unforeseen need for cash generally do not sell assets in a market with discounted values. While BREIT did sell some assets in 2023 to meet its redemption requests, “my assumption is that they would want to hang on to these asset classes as long as possible since they are performing the best and are expected to continue with high performance in the near future,” wrote Schmidt.
Broader market trends bear this out. In the first quarter, investment sales of apartment buildings declined by 25% year-over-year, MSCI Real Assets reported. Sales of industrial properties were down 20%.
According to Gannon, investors and financial advisors indeed feel that BREIT might be overpriced, as evidenced by the fact that inflows haven’t outpaced outflows in the first quarter. Brad Thomas, in his Seeking Apha note, argues that redeeming might be the right move since publicly-traded REITs might offer investors more for their money. But the company has been meeting its redemptions and has not gated them, Gannon said.
“Investors have the last say,” he noted. However, Blackstone has responded well, in his view. “They are standing in there; they are handling the redemptions.”