Nontraded REIT chickens come home to roost at wirehouses, RIAs

With rising interest rates and fears of a recession hanging over the commercial real estate market, two giant nontraded REITs, the $70 billion Blackstone Real Estate Income Trust Inc. and the $14.6 billion Starwood Real Estate Income Trust Inc., this month told investors that they will limit, at least for now, a program in which a restricted number of clients can pull money from the illiquid investments, a process the industry calls share redemption.

The liquidity issue is squarely in the laps of financial advisers who have never dealt with the difficulties posed by nontraded REITs before, namely advisers with registered investment advisers and wirehouses, including Morgan Stanley. Up until almost half-a-decade ago, financial advisers at independent broker-dealers, where advisers are independent contractors and not employees, sold the overwhelming majority of nontraded REITs.

In the past, some nontraded REITs have had issues with shutting off redemptions, unclear valuations, high fees, a lack of liquidity and being able to generate enough revenue to cover monthly and quarterly payments to investors called distributions.

"I don’t care for nontraded REITs, but I do think Blackstone REIT is an outlier and aligned with investors," said Brad Thomas, CEO and senior analyst with Wide Moat Research. "Some investors may have rushed into it, but there's a trade-off between nontraded REITs and those that trade on an exchange. It's between volatility and liquidity. In a listed REIT, there's more volatility but the client gets liquidity. The nontraded REIT appeals to investors who prefer the lack of volatility."

Blackstone's CEO, Stephen Schwarzman, said this week at industry conference that the majority of the REIT's redemptions came from investors in Asia who had been hit hard by market swings, according to multiple news reports.

"Blackstone REIT has delivered extraordinary returns to investors since inception nearly six years ago and is well positioned for the future given its concentration in rental housing and logistics in the Sunbelt and its long-term fixed rate debt structure,” a company spokesperson said.

On Dec. 1, Blackstone REIT told investors that redemptions had exceeded the monthly limit of 2% of its net asset value in October and 5% for the entire quarter, which pushed the company to prorate, or limit and portion investor demands. That means some investors who wanted to get their money out of the fund were turned away — at least for now.

A spokesperson for Morgan Stanley declined to comment about the Blackstone REIT.

And this week, a published report indicated that the Starwood REIT was also limiting client withdrawals.

A spokesperson for Starwood declined to comment on the report.

Launched in 2017, Blackstone REIT has been a behemoth, appealing to financial advisers as a so-called "net asset value" REIT that kicked off steady distributions think dividends, and had lower fees than its competitors. In large part due to regulators, the nontraded REIT industry had already been in flux, lowering fees and commission structures for products, at the time of the Blackstone REIT's launch.

Nontraded REITs have had serious problems in the past, particularly during and after the credit crisis of 2008, when some large nontraded REITs saw their valuations fall precipitously as a result of the sharp declines in commercial real estate. Many financial advisers at independent broker-dealers sold the REITs promising returns that were safe and steady and even "bond-like," to use a term of art.

Unlike publicly traded companies, nontraded investments like REITs or business development companies aren't listed on an exchange, which means there's no immediate market for investors to sell shares if they're worried or thinking it's time to get out. What's different about the Blackstone REIT, referred to as BREIT in the industry, and Starwood REIT are their huge size and the exposure of wirehouse and RIA advisers and clients.

"The [Financial Industry Regulatory Authority Inc.] expects us to treat them like illiquid investments because they can be illiquid," said John Rooney, managing principal at Commonwealth Financial Network, noting that many advisers at the wirehouses have not had long-term experience with the product. "For a long time, the wirehouses blackballed these products, but now with fee-based pricing and quarterly redemptions, nontraded REITs have become available."

Commonwealth Financial Network advisers have sold the Blackstone REIT, Rooney added. "We think it’s a high-quality outfit and a perfect example of a real estate portfolio we have confidence in because of the underlying nature of its capital structure."

The question hanging over financial advisers who have sold such nontraded REITs is clear: Will another significant REIT follow Blackstone and Starwood and move to limit shareholder redemptions?

There's little doubt that many investors are eager to get out of such REITs, one analyst recently noted.

"Monthly fundraising has been declining throughout the year as the Fed has pushed up interest rates," Kevin Gannon, chairman and CEO of Robert A. Stanger & Co. Inc., wrote in a research note last month. "The current monthly run rate is being met by substantial levels of redemptions. For the most recent quarter, redemptions approximated 50% of fundraising. Stanger expects this trend to continue through at least the first quarter of 2023."