Why Blackstone’s US$69 billion property fund is signalling pain ahead for real estate industry

Pain is deepening across the US real estate industry.

Two of the biggest players – Blackstone and Wells Fargo – took steps last week to contend with weaker demand as the industry faces a rapidly cooling property market, rising interest rates and waning investor appetite. 

The well-heeled investors in the US$69 billion Blackstone Real Estate Income Trust (Breit) learned last Thursday (Dec 1) that the fund will limit withdrawals as people seek to pull money from what’s been a cash magnet for one of the largest owners of real estate globally. Also on Thursday, Wells Fargo, the biggest home loan originator among US banks, confirmed that it’s cutting hundreds more mortgage employees as soaring borrowing costs crush demand.

“It’s a one-two punch,” Susan Wachter, real estate professor at the University of Pennsylvania’s Wharton School, said in an interview. “Both are realistic pullback responses to the overall economic weakness we’re seeing now as well as the spike in interest rates.”

In the past decade, the real estate industry reaped the benefits of the Federal Reserve’s policy of low rates. Homebuyers, taking advantage of record-low borrowing costs, went on a spree that fuelled double-digit price gains. Ultra-low rates also drove a refinancing boom that put more money in homeowners’ pockets and spurred the creation of jobs for mortgage brokers, title insurance agents and appraisers. 

Now, real estate has been among the hardest-hit sectors of the Fed’s campaign to quash inflation by boosting interest rates at the fastest pace in decades.

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In the housing market, mortgage rates that have doubled this year are sidelining potential buyers and causing sellers to pull back on new listings. A measure of prices has dropped for the last three months, while pending home sales have fallen for five months in a row. The volume of mortgages with rate locks plunged 61 per cent in October from 2021 levels, according to Black Knight. 

Commercial real estate is also feeling the sting. Property prices have slumped 13 per cent from a peak this year, according to Green Street’s October price index. The financing environment has become trickier as some big lenders have scaled back, leading property owners such as a Brookfield Asset Management unit to warn that it might struggle to refinance certain debt.

The industry fallout has been wide-ranging. Reverse Mortgage Funding, a home lender backed by Starwood Capital Group, filed for Chapter 11 bankruptcy last week.

Layoffs have been widespread. Opendoor Technologies, which pioneered a data-driven spin on home-flipping known as iBuying, laid off about 18 per cent of its workforce and wrote down the value of its property holdings by US$573 million. Brokerage Redfin went through two rounds of layoffs and shuttered its iBuying business, while competitor Compass also made deep cuts to its technology teams in a quest for profitability.

Layoffs only tell part of the story of the pain. While mortgage firms and real estate technology companies cut costs by firing workers, real estate agents make up a large share of the industry’s workforce. They’re usually considered independent contractors and depend on commissions for a living. They don’t show up in layoff tallies but are also exposed to slowing home sales.

“There are hundreds of thousands of real estate agents who are not going to be practising because people are buying and selling fewer homes,” said Mike DelPrete, a scholar-in-residence at the University of Colorado Boulder. “It’s like a silent culling of the ranks.”

When interest rates were ultra low, investors turned to commercial real estate as a source for higher yields than they could get by owning Treasuries and other low-risk bonds.

That was part of Briet’s appeal, drawing in high-net-worth clients lured by the 13 per cent annualised returns in one major share class through October. Breit raked in money to buy apartments and industrial buildings, properties that the private equity firm bet would keep growing in value because demand outstripped supply. People who couldn’t afford to buy a house needed to rent, the reasoning went, and shoppers increasingly buying online drove up the need for warehouse space.

“Our business is built on performance, not fund flows, and performance is rock solid,” a Blackstone spokesperson said last Thursday after the firm announced the redemption limits. 

Much of the money withdrawn from Breit was from overseas, with offshore investors redeeming at eight times the rate of US ones in the past year.

Commercial-property owners are getting hit with financing challenges after years of paying for deals with cheap loans. Expensive debt has pushed some borrowers into negative leverage, which means that debt costs are outpacing expected returns. Dealmaking has also frozen, with transaction volume plunging 43 per cent in October from a year earlier, according to MSCI Real Assets. 

“With the benefits of leverage severely limited and owners who are not being forced to sell, the price expectations gap between sellers and potential buyers has been wide enough to limit deal closings,” Jim Costello, an MSCI economist, wrote in a Nov 16 report.

Despite all the pain points, the housing and commercial real estate industries are in better shape than in some previous downturns, with more tightly underwritten loans and less of a risk of markets being oversupplied.

With Breit, the fund is still outperforming the S&P 500 Index, even as investors increasingly want out. And Thursday’s announced sale of a stake in two Las Vegas hotels is expected to generate roughly US$730 million in profit for Breit shareholders, Bloomberg previously reported.

What’s changing most drastically across the industry is the relative value of real estate to other investments.  

Thanks in part to the Federal Reserve’s hiking campaign, investors have other places to earn money that could generate more yield than in years past and tend to be more liquid than commercial real estate, including Treasuries, investment-grade bonds, and mortgage-backed securities.

“Real estate is quite cyclical,” Wharton’s Wachter said. “It’s bad for real estate when rates go up and you can get higher yields from Treasuries and other assets.” BLOOMBERG