Blackstone’s liability to University of California doubles on property fund losses

Blackstone owes the University of California twice as much as it did last quarter as part of a complex transaction to shore up its flagship real estate fund.

The world’s largest alternative asset manager promised UC an 11.25 per cent annual return from the property fund, called Blackstone Real Estate Income Trust, or Breit, as part of a deal to draw $4.5bn in new investment. But as the fund lost value last year, Blackstone’s liability to UC has grown to $560mn.

It underscores the financial risk Blackstone assumed to draw UC’s investment by promising high returns on property investments hit by rising interest rates.

In late December 2022 and January 2023, Blackstone received a $4.5bn investment from UC that helped Breit meet a spate of redemption requests from other investors and shore up its liquidity. The new cash helped Breit avert a fire sale to meet the requests.

To entice UC, Blackstone made a promise that Breit would achieve 11.25 per cent annualised returns over six years. The US private capital group pledged $1.1bn in Breit shares it owned to guarantee some of those returns. Since the UC investment, Breit’s redemption requests have dropped by about 80 per cent.

But Blackstone has had to record a liability to UC based on how far Breit has fallen below its return promises. In the fourth quarter, Blackstone more than doubled its liability to UC, raising it from $260mn at the end of the third quarter to $560mn by the end of 2023, according to a securities filing.

Breit recorded a 0.5 per cent loss in 2023, its first annual loss since its launch in 2017, putting Blackstone significantly behind on its promised return. Breit’s value fell as Blackstone marked down some property investments. In addition, some interest rate hedges that had gained substantially in value lost ground amid rising expectations of interest rate cuts from the US Federal Reserve.

The annual losses in turn caused Blackstone’s liability to UC to increase. Though it is an accounting entry and no cash or assets are changing hands, the liability reflects the increased risk Blackstone may eventually have to forfeit some Breit shares it owns to the California-based endowment. If Breit’s performance soars in coming years, the liability could reverse or even turn into an asset.

“Since inception seven years ago, Breit has delivered an 11 per cent annualised net return . . . outperforming non-traded Reit peers by [about] 6 percentage points in 2023, making it one of the best performing Reit investments through the pandemic and a period of rising rates,” Blackstone said in a statement.

Blackstone president Jonathan Gray has said he expects property valuations to soon hit bottom as real estate markets absorb the impact of higher rates.

“We really see real estate bottoming from a valuation standpoint,” Gray told the Financial Times last month. “The declining cost of capital with rates coming down and spreads coming down for real estate borrowing is very helpful.”

On a conference call with analysts in January, Gray said Breit had “weathered the storm” in real estate markets, but he warned that Blackstone did not expect to see a “V-sharped recovery” in property values.