The Gating of Private REITs
Hawkeye Wealth Ltd. • January 21, 2023
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Dear Investor,
As many of you know, Hawkeye Wealth sources and evaluates real estate investments with the goal of achieving strong risk-adjusted returns for our clients.
While there is an element of luck that factors into each successful investment, superior insight is the key to stacking the odds in your favour. To this end, we will start providing you with monthly insights related to the private real estate investment industry.
The first topic we would like to discuss is the recent pausing of redemptions (known in the industry as “gating”) of multiple private funds. As you may be aware, a few notable funds such as Blackstone REIT and Starwood REIT have paused redemptions, causing many investors to take notice.
Some of you may have invested (or considered investing) in various private REITs similar to Blackstone or Starwood. While we can’t offer blanket advice because each situation is unique, we’d like to offer a few thoughts that you may find helpful.
- Be watchful of how Net Asset Value (NAV) is reported. For private funds, NAV is often determined quarterly by management teams and their boards (of which the directors are often not independent). As of now, there is no standardized process for calculating NAV in a private REIT and there is a risk that the NAV does not properly reflect the value of the underlying assets in a fund.
There can be multiple reasons for this discrepancy, including inaccurate appraisals and rapidly shifting markets. Some fund managers may also be hesitant to lower NAV for fear of spooking investors and causing redemptions. The irony is that a fund manager’s hesitance to lower NAV may end up causing the redemptions they are trying to avoid. This is because investors might believe they can redeem at a price that is higher than the value of the underlying assets.
If you notice that NAV doesn’t seem to be adjusting to the current market conditions, it may warrant a closer look to make sure you understand why and whether the reasons are legitimate. - Pausing of redemptions in and of itself is not necessarily a cause for alarm. When the underlying assets in a fund aren’t quickly and easily converted to cash, as is the case with most real estate funds, an occasional lack of liquidity may be reasonable. Managing cash is a difficult balancing act for a manager as being fully invested in illiquid assets lessens investors' ability redeem. On the other hand, excess cash in the fund, while great for liquidity, drags down investor returns.
While liquidity is an important element to understand in any fund, do not mistake liquidity risk (i.e. pausing of redemptions) for risk of loss of capital. - When determining your liquidity risk, understanding the fund's redemption terms is not enough. Be sure to consider how quickly and easily the underlying assets can be converted to cash to get a better sense of how long you may have to wait in the event redemptions are paused. For example, a mortgage fund holding primarily three-year loans would generally be subject to more liquidity risk than a mortgage fund focused on shorter-term bridge loans of one year or less.
The liquidity of the underlying assets is a better measure of your liquidity risk than the redemption terms of the fund.
Making sure we understand the liquidity risk of each investment and that you as an investor are properly compensated for that risk is one of many important considerations in our due diligence process. We look forward to providing additional insights in the coming months and if you have any questions or there is anything we can do to help, please feel free to reach out.
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