Blackstone president Tony James is not afraid of competition.
After the real estate giant launched its non-traded real estate investment trust, Blackstone Real Estate Investment Trust, in January, its peers have been following suit: Starwood Capital Group, which filed a registration form in October; CIM Group, which acquired Cole Capital, a long-time sponsor of non-traded REITs, in November; and TH Real Estate, which is planning to register a vehicle in the coming months.
PERE also has heard of at least six other fund managers interested in entering the space to tap a new source of capital, as institutional fundraising slows.
“We’re in finance. There’s nothing that’s patentable, so there’s nothing that other smart competitors can’t imitate,” James said on Blackstone’s third-quarter media call, in response to a question from PERE.
In a video promoting BREIT, Blackstone real estate head Jonathan Gray said the firm seeks to “democratize” access to private real estate, a market historically difficult for retail investors.
“We want to have a fee structure that looks much more like institutional investors. We want investors to understand exactly what we’re doing, how we’re aligned with their interests and how we’re focused on delivering favorable returns,” Gray said.
Gray’s focus on fee structures, alignment and returns is no accident.
In the non-traded REIT sector, there were historical concerns about structures stemming from high front-end fees, a lack of sufficient liquidity and perceived conflicts of interest, said Mark Kaspar, the head of EY’s global REIT practice.
The space began changing five years ago when Cole Capital and Dividend Capital (now BlackCreek Group) introduced NAV or perpetual life REITs, in contrast to the vehicles with lifecycles similar to closed-end private equity real estate funds. That same year, LaSalle Investment Management launched the first product approved by a wirehouse, JLL Income Property Trust. Unlike many previous vehicles, the LaSalle vehicle invested in diversified property types, used a trailing fee structure instead of upfront fees and calculated portfolio value daily.
“In terms of wirehouse distribution, JLL Income Property Trust laid a very clear foundation for the space,” said Anthony Chereso, the president of industry group Investment Program Association.
Between JLL Income Property Trust’s debut and the current crop of entrants, financial regulations spurred changes that have dampened capital raising. In 2015, the Financial Industry Regulatory Authority issued a notice that it would increase transparency in fee structures by requiring sponsors to start publishing net asset values. Legacy vehicles’ sales struggled under the rule as their more onerous fee structures came to light: capital raised in the industry dropped from $10.2 billion in 2015 to $4.6 billion in 2016, according to research firm Blue Vault Partners.
“There is more interest in non-traded REITs now since Blackstone entered the market with a non-traded REIT investment fund that is better aligned than what has historically been the case,” said Dirk Aulabaugh, a managing director at real estate research firm Green Street Advisors. “While the overhead of the Blackstone REIT is more than a large, blue-chip, publicly-traded REIT, it is a big shift from the non-traded REITs of the past with high fees, weak disclosure and a lack of alignment. Others in the industry are changing their business models as well.”
Smaller competitors may also follow Blackstone. “I expect some of the mid-tier real estate fund managers will enter the space,” EY’s Kaspar said. “That’s a group who’s always aggressively competing for capital, and permanent capital is becoming far more important.”
However, he added that few of the firms that initiate conversations about the product eventually launch because of the sector’s complexity. Building a platform internally requires much greater human capital investment to distribute a non-traded REIT product than to market a private fund. One executive who has experience in both the public and private markets noted that a non-traded REIT’s distribution team may comprise 65 or more people across the country, compared with a handful of staff for an institutional fund.
He estimated that 10 managers will enter the market in the next three years, and out of those, five will be profitable, two will be neutral and three would fail. As more sponsors crowd the market, wirehouses will be selective about their offerings, forcing managers to look to the more expensive and time-consuming broker-dealer distribution channel.
The executive also added that some of the world’s biggest fund managers considered starting vehicles but then lost interest.
“Many institutions get interested in non-traded REITs and then when you open up the hood, a lot of people walk away,” he said.