Until a few years ago, non-traded REITs were, along with some other sketchy investments, the red-headed step child of the investment world. Nobody liked them except the people selling them who got paid big commissions to do so. They were often riddled with fraud and insider dealing and have been a consistent source of complaints to FINRA and the SEC. I won’t name any names but if you Google “non-traded REIT fraud” you’ll find plenty of examples.

These investments buy and manage commercial real estate, an illiquid asset in the best of times, and offer quarterly liquidity for investors. They usually have lines of credit to provide liquidity for redemptions if necessary. As long as they bring in new money to replace what’s leaving, any borrowing on the LOC is temporary. But if the new money stops….

In recent years, big investment firms have launched their own versions of these opaque investment vehicles. They worked great when there was plenty of liquidity and interest rates were low because the gate only swung inward; people were buying these things – being sold these things – in a hunt for yield. Now that interest rates have, inevitably, risen, the gate is swinging the other way as a 5% yield on a non-traded REIT doesn’t sound that attractive when you can get the same yield from a T-bill with no risk. And so, these funds are now getting more redemption requests than new investments and they are drawing down their lines of credit to pay investors. Or, in some cases, limiting the amount of redemptions allowed on a quarterly basis.

The two most prominent of these new funds are Blackstone’s BREIT and Starwood Capital’s SREIT and they appear to have some of the same problems as smaller versions. They have both limited withdrawals over the last year as redemptions have exceeded new investments. BREIT did meet all redemption requests last quarter so maybe the worst is past for them, but SREIT just recently limited withdrawals further, from 5% of the fund to 1% (Facing Possible Cash Crunch, Giant Real Estate Fund Limits Withdrawals, NYT, May 23, 2024). And now questions are emerging about how Blackstone values the real estate in the fund (Big Questions Hanging Over A Blackstone Fund, New York Times, May 7, 2024). Blackstone, of course, defends their valuation methods and I have no reason to doubt they are acting in good faith, but I also have no reason to doubt their incentive is to find a way to put a higher value on these illiquid assets. I haven’t heard any similar rumblings about the SREIT fund but it certainly wouldn’t be a surprise. Any fund holding illiquid assets is vulnerable to being challenged about valuations. The obvious example is the private equity industry where claims of lower volatility are sometimes driven by generous views of the value of the portfolio companies.

What I don’t understand is why anyone would buy one of these funds. There are thousands of publicly traded REITs that don’t have these problems. You might not like the price the market is offering for your shares but you can always sell. As for valuation, well, investors have always been emotional in their pricing of publicly traded assets so sometimes the underlying assets will be undervalued by the market and sometimes they will be overvalued; that’s the volatility the non-traded REITs claim to avoid. But they can only avoid acknowledging the market price of their assets if the don’t have to sell. If they get too many redemptions, they have to either limit future redemptions or start to sell their real estate. And, of course, the reason a fund might see redemptions is because there are perceived problems with either their portfolio or the commercial real estate market in general. It is the latter situation, these big funds face and they are doing what funds always do in this situation.

These funds are sold to individual investors by implying that they are getting the inside deal, that investing in the fund gets you something you can’t get in a publicly traded REIT. Blackstone’s website for their fund says, right at the top:

Institutional-quality real estate for individual investors, powered by Blackstone1

BREIT provides individuals access to Blackstone Real Estate, the world’s largest owner of commercial real estate with a 30+ year proven track record of success across market cycles.

There is no doubt that Blackstone is a big owner of commercial real estate and most of their investors are institutions. But you know what you aren’t getting when you buy this fund? Institutional fees. The classes of shares available to small investors carry higher fees and may also be subject to an upfront fee (commission) that their institutional investors don’t pay. In total, there are 12 footnotes on the “Why Invest in BREIT” page of their website. I’d suggest reading them very carefully before sending in a check.

Blackstone and Starwood are very successful real estate investors and I understand why people want to invest with them. But you can’t have your cake and eat it too. If you invest in a non-traded REIT, you have to accept the lack of liquidity and opacity that goes with it. Real estate is not a liquid investment when owned directly and these funds are closer to that than a publicly traded REIT. Hiring Blackstone or Starwood to choose the investments doesn’t change that fact.