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Skyscraper debt hints at future investment strategy for Blackstone's REIT

Blackstone Group LP's nontraded REIT is a major investor in debt backed by the firm's iconic Willis Tower, in a deal that gives retail investors exposure to a slice of real estate finance typically dominated by institutions.

While nontraded REITs sometimes invest in bonds, the Blackstone REIT's relatively large purchase of debt backed by a trophy property stands out in a space that usually deals in smaller, less glamorous assets. Moreover, the building's ownership, by a different Blackstone unit, hints at the way the private equity giant might use its reach, brand name and real estate investing clout to push its advantage in marketing to retail investors.

Blackstone launched the REIT, Blackstone Real Estate Income Trust Inc., in August 2016, and has enjoyed uncommon success raising funds in an otherwise fallow period for nontraded REIT share sales. As of March 22, the REIT said it had sold 47.8 million shares for roughly $10 per share. Other large money managers have been rumored to be following Blackstone into nontraded REIT sponsorship as a means of raising capital from retail investors; Cantor Fitzgerald & Co. launched its own REIT, Rodin Global Property Trust Inc., in October 2016.

The Willis Tower debt investment illustrates one way well-heeled sponsors can raise money from retail investors through nontraded REITs and use it to recapitalize properties they purchased through other vehicles, said Ryan Morfin, a partner at Maroon Capital Group, the investment banking arm of Cabot Lodge Securities LLC, which sells alternative investments including nontraded REITs. The idea would be to buy an asset in need of rehabilitation through a fund with a mandate to take risks, to stabilize the property, and then to sell all or part of it to a vehicle — the REIT — focusing on lower-risk investments.

"I think that's a trend that we're going to see a lot more of, and it will come in different forms," including through investments in commercial mortgage-backed securities or preferred equity, Morfin said. For retail investors, he added, that means "getting a more sophisticated, structured portfolio, versus just direct common equity or debt that they typically see in nontraded REITs."

Outside the box

Blackstone affiliates bought the Willis Tower — the former Sears Tower — for $1.3 billion in 2015. Occupancy at the property was at a historic low of 73% when it was acquired and currently stands around 76.5%, below its 20-year average of 84%, according to an S&P Global Ratings presale report. Blackstone announced in December 2016 that it would undertake an extensive renovation of the property's retail spaces, office suites, building amenities and observation deck, and toward that end, it borrowed $1.02 billion March 22 in a CMBS transaction structured around a loan from Goldman Sachs & Co.

SNL ImageA glass balcony on the 103rd floor of the Willis Tower in Chicago
Source: Associated Press

Blackstone entities were both borrowers and lenders in the CMBS deal. The firm and its affiliates — including the nontraded REIT — bought 49% of the debt being sold, across multiple tranches of the offering.

The REIT's roughly 11% slice of the debt, purchased for $116 million, is its largest investment since it began selling shares. It exceeds the combined price the company paid for its three real estate properties: a hotel in Davis, Calif.; an apartment building in Mesa, Ariz.; and an industrial park in Stockton, Calif. The REIT also has another CMBS investment, worth roughly $17 million, backed by unspecified "hospitality-related collateral."

Peter Fass, co-head of the real estate capital markets group at Proskauer Rose LLP, said several nontraded REITs have invested in CMBS bonds because they offer attractive yield to support the REITs' dividends, and because they are relatively liquid in comparison to real estate properties. More nontraded REITs, like Blackstone's, are offering periodic stock redemptions in response to shareholder demand, and holding liquid securities can help REITs be assured that they can fund those payments, Fass said.

Still, the Blackstone investment is unique, according to James Sprow, director of research at the independent nontraded REIT research firm BlueVault.

"Just by virtue of their size and the amount of capital they've raised so far, this is huge compared to what other nontraded REITs that are investing in debt instruments would be able to do," Sprow said. "Those REITs that are out there investing in commercial real estate debt instruments, I'm not sure that the total assets they've invested would add up to what Blackstone raised in the fourth quarter."

Family matters

A Blackstone spokeswoman declined to comment for this article. Nontraded REIT observers said the Willis Tower investment, while unusual, appears consistent with the Blackstone REIT's stated investment strategy, and Fass emphasized that income from CMBS is permissible for REITs to receive under IRS regulations. Still, the transaction raises some delicate issues.

The REIT's filings describe, at length, the potential for conflicts of interest in deals between it and various other Blackstone entities, and lay out procedures for so-called "affiliate transactions." In short, a committee made up of the REIT's four independent directors reviews all transactions with Blackstone or related parties to make sure they are fair to the REIT and its shareholders. Even so, Sprow said investors and broker-dealer representatives often wonder where nontraded REITs sponsored by large managers fit within their broader brand families.

"If you have a lot of other irons in the fire, if you're a global giant like Blackstone, how do you allocate deals to the various investment programs that you have?" Sprow said. "If I invest in this Blackstone REIT, how do I know that I'm getting a fair shake in terms of the deals that are coming across the table at Blackstone? … Everyone wants to know, are we getting leftovers?"

Morfin said transactions between different investment platforms with the same sponsor usually raise questions. While Blackstone is unlikely to risk its reputation by shortchanging one group of investors at the expense of another, he said, investors and due diligence officers should be aware that the REIT may be dealing with related entities, and they should pay close attention to property valuations and appraisals.

While being in the Blackstone family may give the REIT access to larger and more prestigious assets, portfolio diversity could also be a concern, Morfin said. "Since they are playing commercial real estate at the institutional level, you're going to see assets that are much lumpier and bigger in size," he said.

A smaller nontraded REIT would never commit as much capital as Blackstone's has to a single CMBS investment, Sprow said. Yet if Blackstone can really raise up to $5 billion through the REIT, as it says it intends to, then the usual concerns may not apply.

"If Blackstone has a pipeline of deals that their organization is able to organize and put on the table for their nontraded REIT to consider and invest in, that's an advantage," Sprow said. In a multibillion-dollar fund, he added, "you can make a lot of $100 million investments and still be well-diversified."

S&P Global Ratings and S&P Global Market Intelligence are owned by S&P Global Inc.