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It’s been a while since Alphaville checked in on our favourite unlisted real estate investment trust, but mainFT’s Antoine Gara alerted us to an interesting JPMorgan report on the topic that deserves highlighting.
To recap, the Blackstone Real Estate Investment Income Trust was a commercial juggernaut in the ZIRP era, growing to nearly $130bn in assets and becoming the crown jewel of the investment manager’s real estate empire.
But in December 2022 it was forced to limit withdrawals, as investors leaping to cash out at BREIT’s juicy and seemingly rates-unaffected net asset value swamped the fund’s cash-generating capacities. Cue lots of shrill headlines.
Blackstone then struck an opportunistic deal with the University of California’s endowment to buttress BREIT. In return for a $4bn investment for six years, Blackstone guaranteed UC a minimum annualised net return of 11.25 per cent — with a $1bn backstop of the asset manager’s own BREIT shares. UC subsequently invested another $500mn on the same terms, and Blackstone lifted the backstop to $1.125bn.
Unfortunately, BREIT’s performance subsequently flatlined, forcing Blackstone to report a growing potential liability on the deal.
Antoine flagged almost a year ago how Blackstone’s liability to the University of California had grown to $560mn by then, after BREIT’s 0.5 per cent loss in 2023. BREIT returned 1.95 per cent last year, but this still means it has fallen even further behind its performance guarantee to UC.
So what’s the damage now? JPMorgan analyst Kenneth Worthington last week estimated that the overall hit is “closing in on max loss” and will hit about $900mn if current trends continue. Alphaville’s emphasis below:
Should the required average annual 11.25% return not be met, beginning in 2028 UC will have the options to sell down the BREIT shares it will received from BX as collateral over a ratable two year period each quarter. Our understanding is that such activity would show up as negative investment income for BX in the distributable earnings P&L over those quarters from 2028-2030 should UC choose to sell. We understand that $1.25bn is the maximum number that BX could be on the hook for based on the price of the BREIT posted as collateral at the time of the agreement. We note further that the agreement was struck in terms of shares, and so if the NAV is lower when the collateral held shares may need to be delivered to UC (which would likely be the case if performance has been sub par during the agreement period, BX would actually be on the hook for less than $1.25bn.
Based on the value of the BREIT shares when the agreement was struck, we estimate Blackstone is on pace to forfeit ~$0.90bn of the $1.25bn of collateral backstopping the U-Cal contract. That said, we do point out that since the crystallization period for the UC agreement is six years (four years from now), Blackstone still has substantial time to dig out of the lower than run rate returns in 2023 and 2024. Still . . . we estimate that BREIT will now need to generate average returns of ~17% for the remaining four years to avoid forfeiting its collateral. BREIT has topped this return level in only one year since its 2017 inception, when it generated 30.19% returns in 2021.
It should be stressed — as Worthington does in his report — that the overall damage to Blackstone will be softened by the UC paying full fees on its $4.5bn investment (in fact, UC committed to paying slightly higher fees if the performance beat the agreed hurdle rate, but that looks vanishingly unlikely now).
At the time, Blackstone estimated that as long as BREIT generated an annualised net return of 8.7 per cent or higher it would still make a profit, thanks to those extra fees.
However, at the moment even the 8.7 per cent hurdle looks beyond BREIT, given how far it has fallen behind already. Especially if DeepSeekmageddon stymies the growth in data centres — one of the investment vehicle’s biggest bets. In a statement Blackstone said:
BREIT has delivered a ~9.5% annualized net return on Class I since inception eight years ago, ~65% higher than publicly traded REITs.
It is important to note that there are more than 4 years remaining on the UC agreement and BREIT owns an exceptional portfolio of real estate. That said, in a full payout to UC scenario, we would expect the cumulative net financial impact to Blackstone shareholders to be less than half the value of the BREIT collateral because Blackstone is earning full base and incentive fees on the UC capital, and our investment professionals are sharing in the cost of any shortfall.
