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Can Blackstone Rescue the Non-Traded REIT Sector?

Lower Fee Structures at the Heart of Latest Enticements
August 17, 2016
In a surprising move that could radically reshape the beleagured non-traded REIT industry, Blackstone Real Estate is launching its first non-traded REIT -- Blackstone Real Estate Income Trust Inc. -- but with major differences in its proposed fee structure and capital-raising process.

An affiliate of the $100 billion private-equity behemoth has filed an initial public offering to raise up to $5 billion from investors with plans to invest in stablized, income-oriented commercial real estate properties and securities.

The decision to enter the non-traded REIT sector comes as a major contrarian move for Blackstone, which has had no trouble raising substantial sums for real estate investment through various other sources.

Meanwhile, the non-traded REIT sector has all but dried up after a series of accounting scandals and charges of excessive fees soured investors on the formerly popular sector. Capital raising plunged 20% in 2014 (with approximately $16 billion in equity raised) and 2015 sales were down 36% year over year, according to NorthStar Realty.

Last summer, the U.S. Securities & Exchange Commission issued an investor alert about non-traded REITs, with one of alerts addressing the high fees charged by non-traded REITs.

This year, new reporting regulations kicked in requiring non-traded REITs to disclose more accurate and timely information on the actual value of their investments as well as on broker commissions and fees paid by investors.

The impact of these new regs has been an even sharper decline in capital raising. Overall non-traded REIT capital raising is down 57% through June 2016 compared to the first half of 2015, NorthStar Realty reported.

Non-traded REITs typically rely on networks of independent broker-dealers to sell their shares. Many of these middle men charge high upfront fees that can represent up to 15% of the offering price, which lowers the value and return of your investment and leaves less money for the REIT to invest, according to the SEC.

In addition to the high upfront fees, non-traded REITs may have significant transaction costs, such as property acquisition fees and asset management fees.

High-Fee Model Ripe for Disruption?

With its new offering, Blackstone hopes to turn this high-fee sector on its head, undercutting competitors by capping fees at less than 7%. It also will offer investors the option to choose among four different classes of shares, each with variations on its fee structure and different distributions.

In addition, Blackstone will set a return ‘hurdle amount,’ which is a minimum internal rate of return of 5% that has to be achieved before it is entitled to any performance allocation.

Such an investment structure is more typical in the institutional investor world in which Blackstone typically operates but represents an entirely new approach within the non-exchange traded REIT industry.

Although unconfirmed, the private equity giant is also reported to be planning to go around the broker-dealer networks and their high-fee structures and instead sell shares in the new REIT through wirehouses such as Morgan Stanley and Merrill Lynch, with which it has longstanding business ties.

Blackstone Not Alone in Cutting Fees

Given the impact on fundraising by the new securities regulations and SEC warnings, both old and other new entrants in the non-traded REIT sector are making changes to their business plans with the goal of squeezing out costs and reducing fees.

Last week, Inland Real Estate Investment Corp., one of the largest sponsors of non-exchange listed REITs, announced it was eliminating real estate-related transaction fees for currently offered and future non-listed REITs.

Real estate-related transaction fees are typically levied by sponsors for the acquisition, disposition and financing of real estate. Blackstone REIT will not be charging these fees either.

"By eliminating transaction fees, we have the opportunity to improve funds from operations and net income, reduce potential conflicts of interest, and better align our interests with those of our REIT investors," said Mitchell Sabshon, president and CEO of Inland Investments.

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