Beware Blackstone Real Estate Funds – Public REITs Are Better (NYSE:BX)


CHUNYIP WONG

Black stone (NYSE: BX) is among the most successful fund managers in the world, but keep in mind that success in this world is not determined by the returns provided to investors, but rather by the scale of assets under management.

Blackstone’s 2Q22 earnings conference call revealed a company determined to grow its assets under management at all costs. They use a gap in performance ratios between private and public to suggest an extraordinary amount of alpha to the tune of 3000 basis points. Basically, however, the performance of their real estate funds was probably roughly in line with that of public REITs.

From the tone of the call, they seem to be making hay while the sun is shining – using the temporary alpha as a way to pump up the surges. This works according to the conference call where Jonathan Gray said:

“Overall, in retail, we had $15.5 billion in inflows, which is very remarkable. In the 3 products, mainly BREIT and BCRED »

This article is a warning that now is a terrible time to invest in BREIT, BCRED or most private real estate vehicles. Frankly, public REITs are a much better investment right now. I will elaborate further below, but to summarize this argument consists of 3 premises

  1. The alpha achieved at BREIT is misleading and will almost certainly reverse
  2. Private real estate is constantly at NAV
  3. Public real estate is heavily discounted against NAV

Once fully fleshed out, I will demonstrate that these premises suggest that public REITs will outperform private real estate vehicles in the future.

Misleading alpha presentation

Stephen Schwarzman on Blackstone’s 2Q22 earnings conference call.

“In real estate, while the public REIT index fell 17% over the quarter, our Core+ funds rose 2.3%. I will do it again for you. The index is down 17%, we were up 2.3%.

He kept bragging

“For the first 6 months of the year, our real estate strategies appreciated by 9 to 10% against a 20% drop in the REIT index, an outperformance of around 3,000 basis points. I don’t know many asset classes that outperform indices by 3,000 basis points.

Wow 3000 bps in 6 months is amazing.

Here is the problem….

These are not kosher performance reports. It’s apples to oranges.

It compares BREIT’s net asset value and dividend yield to changes in public REIT market prices. If one digs into the supplement, the performance is more accurately disclosed. The chart below shows BREIT with a 13% annualized return since 2017, but more importantly, it has an L footnote.

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Bx

Footnote L states the following:

“Unless otherwise stated, total net return represents the annualized IRR as of June 30, 2022 on total invested capital based on realized revenue and unrealized value, as applicable, after management fees, expenses and performance income. IRRs are calculated using the actual timing of investors’ cash flows. The initial creation date of the cash flows occurred in the year of creation”

The key to this footnote is that performance is realized product and unrealized value. This means that they value the real estate held by these funds at some kind of calculated value such as a net asset value.

I think this approach to valuing their own funds is reasonably fair. Essentially, the net asset value can be calculated with some degree of accuracy using the net operating income (NOI) which is a known figure and the cap rates of comparable transactions which are known within a range.

So I fully believe that BREIT has generated a 9-10% return in the first 6 months of 2022 as suggested by Schwarzman on the call.

The problem comes from the unfair comparison with the REIT index. If you use NAV as the valuation basis, you must use NAV for the comparison.

It is unfair to compare NAV to market prices and call it alpha because market prices float on whims, fears and noise.

The implication of using this comparison and suggesting 3000 bps of alpha is that BREIT’s asset selection is so superior that their assets win while everything else fails.

Well, if you use an apples-to-apples comparison, it turns out the rest wins, too.

BREIT consists primarily of rental housing and industrial properties.

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Bx

Let’s take a look at the net asset value of publicly traded REITs in these sectors.

Rental housing consists mainly of apartments and single-family dwellings. Apartment REITs gained some net asset value due to rising rental rates. Camden (CPT), for example, increased its net asset value from around $130 to around $170.

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S&P Global Market Intelligence

Single-family rental REITs Invitation Homes (INVH) and Tricon Residential (TCN) both significantly increased their net asset values.

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S&P Global Market Intelligence

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S&P Global Market Intelligence

Net asset value increases are also prevalent in the industrials sector, with Rexford (REXR) and Prologis (PLD) posting substantial gains.

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S&P Global Market Intelligence

To me, it looks like BREIT works in line with its peers. Real estate is doing well. It doesn’t matter if it’s public or private. The only difference is that public real estate is familiarly measured by the capricious market price barometer.

All assumed alpha is just a matter of comparing NAV to market price. NAV to NAV there is no substantial difference.

In the future there is a difference

Private market real estate essentially automatically resets to be assessed at net asset value. When an investor buys BREIT, they are functionally putting their money into a pool that will end up buying properties at NAV or slightly above NAV because there are fees.

Public market REITs are quoted where the market prices are.

If public REITs are below NAV they are a better deal than private and if above NAV they are a worse deal.

REIT market prices tend to follow NAV over time, but due to market noise, they can deviate significantly in either direction.

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Generated by author

It might be better to buy private real estate when publicly traded REITs are more expensive than NAV because then you can buy it at NAV. Today, however, it seems foolish to buy at NAV when REITs are trading at a huge discount.

The average publicly traded REIT is priced at 82.5% of NAV and the median is 82.3%.

Why pay $100 plus fees with BREIT when you can buy similar properties for $82.30?

The irony of Blackstone’s BREIT talk of increasing assets under management is that it is precisely the 3000 basis points of “alpha” that will cause BREIT to underperform public REITs in the future.

This alpha was nothing more than public REITs going cheap and when public REITs inevitably return to net asset value, they will recoup that performance.

An even better approach may be to buy deeply discounted REITs and then sell them back to Blackstone at full price.

Buy REITs that are about to be acquired by Blackstone

Blackstone’s fundraising has been so remarkably successful that their inflows exceed their acquisitions. That left them with an unprecedented $170 billion worth of dry powder.

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Bx

$59 billion is for real estate. They will buy properties from REITs and, in many cases, buy directly from public REITs.

They’ve already bought quite a few REITs. From the top of my head

  • Public Storage Business Parks (PSB)
  • Extended Stay in America (STAY)
  • Bluerock Residential (BRG)
  • Preferred Apartment Communities (APTS)
  • American University Communities (ACC)
  • QTS Real Estate Trust (QTS)

Others will almost certainly be purchased. In each case, the target gets a nice premium to the market price, so owning the target is better than being the buyer.

Based on Blackstone’s pattern of purchases in the past, here are the REITs that I believe are most likely to be purchased by Blackstone:

  • Tricon Residential: Blackstone already has a dominant position in TCN.
  • Apple Hospitality (APLE) and Chatham Lodging (CLDT): We know BX loves extended stay hotels.
  • NexPoint Residential (NXRT), BRT Apartments (BRT), Independence Realty (IRT) and BSR REIT (OTCPK:BSRTF) appear to be next after APTS and BRG.

I particularly like NXRT, BRT, BSRTF and TCN because they are fundamentally strong companies trading at attractive valuations that can provide strong returns to investors with or without a buyout.

Clarification on the thesis

I’m bearish on BREIT, not necessarily bearish on Blackstone (BX). As an asset manager, Blackstone benefits from commission income generated by BREIT and its other vehicles. Even if these vehicles underperform as I expect, BX can still perform well. Thus, I view BX as a holdback and my disclaimer is strictly for private real estate vehicles like BREIT.

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