Starwood May Be Just The Start: Experts See Problems Under The Hood For Huge CRE Funds

Multibillion-dollar real estate funds run by some of the biggest names in the investing world are facing liquidity pressures that have become increasingly dire over the last year and have bubbled to the surface over the last two weeks. 

Starwood Real Estate Income Trust, the $10B nontraded REIT run by Starwood Capital Group, on May 23 tightened the limit on the amount of investor redemptions it would pay out to 0.33% of its net asset value per month, down from 2%, as it tries to preserve liquidity and wait for the market to recover. 

Several other nontraded REITs, a segment of real estate funds that skyrocketed with billions of dollars raised before interest rate hikes began to hammer the sector, are at risk of similar situations as they see investors pulling money out at a far faster rate than they can bring in new cash. 

As interest rates appear poised to stay higher for longer, selling properties in today's market remains an unappealing option to raise capital. Experts in the sector tell Bisnow this could lead other nontraded REITs to place tight restrictions on withdrawals, a move that only makes it harder to bring in new money. 

"I suspect that this was not a problem that's isolated to SREIT alone," said Leyla Kunimoto, an accredited real estate investor who has closely followed nontraded REITs but chosen not to invest in them.

"I can see how this could be a wider problem than just the one REIT," she added. "This is probably going on under the hood in some other nontraded REITs."

Nontraded REITs have seen a steady decline in fundraising over the last two years, falling from $12B in the first quarter of 2022 to $1.4B in the first quarter of this year, according to Robert A. Stanger & Co., the leading data source tracking the sector. 

At the same time, investor redemptions paid out by nontraded REITs went up from $12B in 2022 to $18B in 2023 and are on pace to surpass that this year. 

On top of this fundraising-redemption imbalance, REITs are facing falling property values and looming debt maturities, putting them in a precarious financial position as they try to raise money to plug the gaps.

"Anyone who's in a negative fund flow position is moving towards having the liquidity issues," Stanger CEO Kevin Gannon said. "That'll happen depending on how long this lasts. If it lasts six more months, maybe not. If it lasts another year, year and a half, maybe so."

Kunimoto said there are two things making it difficult for nontraded REITs to attract new fundraising dollars at the moment: their net asset value is higher than those in the public sector, and the illiquidity or restrictions on investor redemptions. She has invested in public REITs and private real estate deals but has decided to stay away from nontraded REITs. 

Nontraded REITs don’t have to disclose as much financial information as their publicly traded counterparts, and their share prices are based on the company's own calculations of net asset value rather than relying on the stock market to price its shares. 

From the end of 2021 through the first quarter of this year, weighted NAV for nontraded REITs fell 3.26%, compared to a 14.2% drop in NAV for publicly traded REITs, according to Stanger's data.

"You have something like Starwood's SREIT is assuming 'we're not going to sell our assets for six years,' and in the meantime, they're going to grow at 6% a year, which is well above the [gross domestic product] and inflation and the regular market growth," said Kris Rymer, an accredited investor and adviser who wrote an in-depth blog post last month about the way nontraded REITs measure NAVs. 

"When you're marking something at NAV for investors to buy today, you need to reflect the current market conditions," he added. 

Starwood's decision last month to sharply restrict investor withdrawals came after a May 15 Financial Times report that it had only $225M left from its $1.6B line of credit. Along with dropping its monthly withdrawal cap to 0.33%, it cut its management fees. It expects these measures to stay in place for the next six to 12 months. 

CEO Barry Sternlicht said in a letter to investors at the time that Starwood believes this is a better move than selling assets to raise liquidity at a time when values are depressed. 

"We have built an exceptional portfolio of high-quality real estate – as evidenced by our same-store NOI growth in the first quarter which is best in our competitive set and more than twice that of the average non-traded REIT peer," Sternlicht said in a statement to Bisnow for this story. "SREIT maintains a sound balance sheet and continues to be well positioned to navigate through the current environment."

Investors in nontraded REITs receive periodic distributions, and many reinvest those back into the funds, adding more money on top of the new fundraising they bring in. Stanger analyzes the liquidity of nontraded REITs by looking at the ratio of their fundraising and reinvested dividends — the money coming in — to the investor redemptions — the money going out.

Starwood REIT had the highest ratio of all the nontraded REITs Stanger tracks at 529.3% as of Q1, meaning it paid out more than five times the amount of money it brought in.

"That's not desirable if you're the sponsor," Gannon said. "There's a couple others that have had challenges."

Indeed, Starwood wasn’t alone in having a high ratio. The first-quarter average of the nontraded REITs Stanger tracks was 214.6%, and several big-name investors had ratios over 200%. Blackstone REIT’s was 373%, KKR’s was 244.4% and Brookfield’s was 214%.

Blackstone's $60B BREIT was the first to limit redemptions in late 2022, and it continued to do so until early this year. In February, BREIT fulfilled all of the $961M in redemptions that were requested, and in March it fulfilled all $799M of its requests. 

"It is business as usual at BREIT," a Blackstone representative wrote in a statement to Bisnow. "Its semiliquid structure is working as designed and we have no plans to amend our share repurchase program."

SREIT appears to be the only major nontraded REIT to tighten its withdrawal cap so far this year. Several of the other big nontraded REITs Bisnow reached out to for comment said they aren't planning to change their policies. 

Brookfield REIT has also satisfied 100% of its redemption requests without any limitations since it formed in 2019, and it doesn’t plan to amend its withdrawal limit, a source familiar with the fund's operations told Bisnow.

KKR's KREST has maintained a redemption limit of 5% of NAV per quarter and hasn't changed that this year, according to an April investor letter. KREST has maintained a "robust and multifaceted liquidity position" that represented 31% of its NAV as of April, it said in the letter. 

The liquidity issues that nontraded REITs face could be alleviated by raising more fresh capital, but their fundraising totals have been going in the wrong direction.

After raising $19.4B in 2022, BREIT raised $6.5B last year and $493M in the first quarter of this year, according to Stanger's data. SREIT's fundraising has fallen from $5.4B in 2022 to $335M last year to $53M in Q1. 

KKR's KREST saw fundraising drop from $906M in 2022 to $155M last year to $20M in Q1. And Brookfield REIT's fundraising went from $617M in 2022, to $97M last year to $15M in Q1. 

Kunimoto said that the redemption limits and relatively high NAVs have made it harder for nontraded REITs to raise money, as investors see them as less liquid and more expensive than public REITs. 

"It's a kind of a self-perpetuating cycle," Kunimoto said. "They have to sell those shares. And because those shares are not trading in a public market, investors like myself are less likely to start making allocations to them."

The slow fundraising and high redemption rates are just part of the problem for these REITs moving forward.

Many of these nontraded REITs have used floating rate debt which they have hedged with interest rate caps and swaps that could soon expire, and it is more costly to refinance or buy new rate caps as interest rates remain high. 

Additionally, commercial property prices have continued to trend down, reducing their asset values and making it unappealing to sell properties. In April, Green Street's Commercial Property Price Index was down 21% from its March 2022 peak. 

"If rates don't come down in less than the next two years and those rate caps expire, they can't hold those properties for five to 10 years and sell them at those valuations," Rymer said. "A lot of other real estate managers are getting stuck handing keys over to the bank."