Blackstone Fund Deal Highlights Private Market Risks

Private equity giant Blackstone (BX) wants to get more retail investors into its funds, which aren't publicly traded and invest in illiquid assets such as commercial real estate. The company's $4 billion deal with the University of California shows that some of the firm's investors are more equal than others.

While Blackstone said the UCal investment in a flagship fund is a "validation'' of its retail strategy, the firm is also giving preferential treatment to the endowment following a crush of fund redemption requests, highlighting the risks of retail investors' growing exposure to the frequently illiquid alternative investments.

The $68 billion Blackstone Real Estate Income Trust, a leader among the growing number of non-traded REITs, said on Dec. 1 it would limit investor redemptions after such requests exceeded its preset limits.

On Tuesday, BREIT addressed the liquidity strains it faced by announcing a $4 billion investment by UCal's investments manager for a minimum of six years. The investment will have a hurdle rate of 11.25%, and if annual returns fall short of that goal Blackstone is to make up as much as $1 billion of the shortfall. So while the university system will buy the fund's shares at the same price as other investors, it will be doing so with a backstop they lack.

The alternative investments industry is courting Main Street at a time when institutional allocators are playing defense, notably in troubled asset classes such as commercial real estate. Alternative investments recently accounted for just 1% to 2% of individual investors' portfolios, vs. a range of 15% to 50% for institutional investors.

The problem is, it's hard to know what an asset is worth if it doesn't trade regularly. "The thing about nontraded funds and illiquid assets is their valuations as reflected in net asset value are stale," said Spencer Couts, assistant professor at University of Southern California and an expert on alternative investments.

"In our view, the transaction provides a negative read-through to the commercial real estate sector based on a higher cost of capital” demanded by potential investors," Keefe, Bruyette & Woods analysts said in a research note.

BREIT plans to continue restricting redemptions exceeding its preset limits despite the deal, the fund said. The hope is that the endowment's investment will succeed in shoring up the confidence of fund investors who have rushed for the exits. Top Blackstone executives have attributed the redemption rush to financially distressed investors, notably from Asia.

BREIT returned 8.4% for the first 11 months of 2022 and an annualized 12.7% since its 2017 inception through November, net of annual management fees of 1.25% of net asset value (NAV), performance incentives for fund management, and up-front loads of up to 3.5%.

Blackstone is counting on strong historical results to attract more retail investors disappointed with last year's losses in stocks and bonds. In December, the minimum BREIT investment through Fidelity Investments' platform dropped to just $2,500 from $1 million previously.

Those stale valuations, also known as marks, are what encouraged the recent rush of redemptions from BREIT as well as a fund managed by Starwood Capital amid steep declines in the prices of publicly traded real estate investment trusts, Couts said.

Redemption curbs protect investors who remain in the fund by averting forced sales of illiquid assets to meet the redemption requests, according to Couts. Investors who have asked BREIT and other nontraded REITS to return their money were responding to real estate's weakening fundamentals, he added.

Blackstone's share price fell 43% in 2022 and is down 15% since BREIT limited redemptions. The stock gained 5% over the first two trading sessions of 2023.