How real estate managers value their underlying properties has come up in the news recently. The $59 billion Blackstone Real Estate Income Trust — more commonly known as BREIT — valuation process has fallen into question. In a New York Times Article, “The Big Questions Hanging Over a Blackstone Fund,” on May 7, 2024
link: https://www.nytimes.com/2024/05/07/business/dealbook/blackstone-breit-fund-debate.html, it stated:
Many major firms rely on a third-party appraiser to determine the worth of a fund’s assets, in part so investors can trust that the appraised value is accurate and not unduly influenced by the firms. (Those appraisals help to determine a firm’s management fees: The higher the appraisal value, the higher the fees.)
Blackstone appears to do it differently. While it uses a third-party appraiser and an outside auditor, the firm has the final say on the appraised value of its own assets.
Blackstone is open about its approach. From a recent prospectus: “These assumptions are determined by the Advisor, and reviewed by our independent valuation advisor.”
While Blackstone discloses how it determines the final valuation, some on Wall Street have questioned how much latitude firms should have in appraising their own assets.
The BREIT prospectus states how Blackstone values its real estate,
With the approval of our board of directors, including a majority of our independent directors, we have engaged and may in the future engage one or more independent valuation advisors with respect to our real estate properties and certain real estate debt and other securities to review internal valuations prepared by the Adviser for reasonableness. All references herein to “independent valuation advisor” refer to any independent valuation advisors then-currently engaged by us, unless the context requires otherwise.
DDW believes that BREIT and its managers have a conflict of interest when valuing its real estate because the higher the real estate value, the more fees Blackstone can collect.
DDW reviewed the monthly percentage change of NAV of BREIT versus S&P Real Estate Index from Jan 2020 to April 2024.
Both the REIT and Index start at 100. BREIT NAV is smoothed out which is typical for private real estate REITs. The index is more volatile than BREIT because it is marked to market on a daily basis. Between 2022 and 2023 the Index had negative performance where BREIT was at a fairly consistent level.
The following table shows the performance difference between BREIT and the index over two different interest rate time periods. From 2000 to 2022, interest rates were low, and from 2022 to April 2024 where interest rates rose and were kept at that level. DDW is concerned that BREIT from 2022 to April 2024 is only down 2.34% while the index is down 17.45%. But the reason for the difference could be justifiable depending the market and underlying real estate.
DDW compared the BREITs' Exit Cap Rates to the current cap rates in the market from reputable industry sources. Exit cap rates are a large factor in determining the value of an asset, but they are not the only variable used. Other variables in determining the value of the real estate are the discount rate, revenue and expense assumptions, leasing agreements, and capital improvement projects. DDW is relying on the assumptions made by Blackstone with the other variables to isolate exit cap rates.
The following table is broken down by real estate asset class and the allocation of the REIT to that asset class as of April 2024. Along with the Exit Cap Rate disclosed in BREIT filings, the current industry cap rates in the market and where BREITs weighted average cap rate is relative to the high and low cap rates within that specific real estate asset class.
The four sectors that are within the industry band are rental housing, industrial, data centers, and retail, which makes up 89% of the REIT. With self storage and hospitality, those asset classes are outside of the bands on the more conservative side.
With Net Lease and Office, the exit cap rates are outside of the bands but on the more aggressive side. The positive notion is that these asset classes only comprise 8% of the portfolio.
DDW dug into the net lease sector, and those investments are iconic Las Vegas hotels with a net lease. The cap rate band in the table above is for net leases that include CVS, Walgreens, and Dollar General. A net Lease hotel would probably be similar to a net lease office. That aspect would be contingent on the credit rating of the lessor. The credit rating of MGM International as of April 2024 was below investment grade.
The Boulder Group stated that cap rates for single-tenant office and industrial properties stood at 7.6% and 7.02%. BREITs exit cap rate is outside of that band. This is a concern, but it is only 5% of the assets of the portfolio. Without more information on how BREIT values this asset class DDW can say this one factor is outside of the current industry norms but cannot state that BREIT is overvaluing this asset.
For the Office asset class, the weighted average cap rate for BREIT is 5.30%, which is more aggressive than the cap rate band provided by CBRE. CBRE states that the lowest cap rate in the office sector within the US is in downtown Manhattan, New York, currently at the band of 6.00 to 6.50. BREIT does own 1 office building in Manhattan, but the other locations are spread out internationally and throughout the United States. This is a concern, but it is only 3% of the portfolio's assets.
Without more information on how BREIT values this asset class DDW can say this one factor is outside of the current industry norms but cannot state that BREIT is overvaluing this asset.
Office and Net Lease asset classes account for 8% of the portfolio. If Blackstone overvalued those specific asset classes by 20%, the effect on the NAV would account for less than a 2% decrease in the NAV of the offering. Please see the NAV calculations below:
- BREIT NAV as of April 2024: $14.91
- Office and Net Lease Sector percentage of portfolio: 8.00%
14.91 * 8.00% = 1.192
1.192 * 80% = 0.9536
1.192 – 0.9536 = .2384
0.2384 / 14.91 = 1.59%
To get a 5.0% move in NAV, Blackstone would have to overvalue these assets by 88.86%, which seems extreme.