Blackstone’s Mr Fix-It profits with Japanese buy-and-hold bet

Newer set of funds focuses on real estate in Japan that offers a more predictable income stream

Blackstone Group became one of the world’s top property investors by sticking to Jonathan Gray’s preferred formula for market-beating returns: buy it, fix it, sell it.

These days, the firm’s president and former head of real estate is also embracing a more restrained approach: buy it, and hold it for a while with a more hands off approach.

This newer area for fast fundraising growth at Blackstone is a set of funds that invest in properties with fewer problems and offer steadier, if typically more modest, returns.

Blackstone has raised about $29.4bn for the strategy, known in the industry as core plus, according to its most recent filings. That amount – which doesn’t include Blackstone’s non traded real estate investment trust – is still a small part of the firm’s $163bn raised overall for real estate, most of it in higher-risk products. But Gray said in a 2018 investor presentation that the business “could go from $250m of revenues today to $1bn in the next few years”.

In the latest example of this kind of investing, Blackstone has agreed to pay more than ¥300bn ($2.7bn) for a portfolio of 220 apartment buildings mostly in Tokyo and Osaka, markets that have seen very little rental growth in years, according to people familiar with the matter.

The more predictable income stream from properties like the Japanese apartments make these funds appealing to pensions, endowments and other big investors seeking less risk. Many investors also recognise that shooting for higher returns is trickier these days because property values have risen for much of the past decade.

Blackstone has launched three open-ended core-plus funds since 2014: one that focuses on the US, one on Europe and one for Asia. As of December, Blackstone’s lower risk funds were chalking up annual returns in the 10% range, compared with 16% for its riskier “opportunistic” funds, filings show.

Blackstone has also based its first offering to small individual investors on the lower-risk strategy, another sign the firm is diversifying its approach after an early focus on riskier investments. In 2017, Blackstone launched a non traded real estate investment trust with investments as low as $2,500, posting returns of about 10% net of fees since its inception. It raised $12.5bn as of Dec. 31, according to the firm’s filings.

Pension funds and other institutions have been increasing allocations to real estate overall in recent years and have a lot riding on these types of lower risk strategies. For example, 85.2% of the $34.8bn in real estate investments held by the giant California Public Employees’ Retirement System (Calpers), were invested in lower risk strategies as of June 30.

Lower risk funds can run into trouble, too. UBS Group’s low risk Trumbull Property Fund is facing about $7 bn of redemption requests partly because of its relatively high exposure to retail properties.

Still, Blackstone’s bet on the Japanese apartment portfolio shows how the firm is trying to limit its downside while still delivering low double-digit returns.

In an unusual twist, Blackstone already owned most of the Japanese properties three years ago. The firm sold the portfolio in 2017 to Anbang Insurance Group for ¥260bn. Anbang put the properties on the market two years later as it came under financial pressure. Blackstone agreed earlier this year to buy it back.

Without performing any major fixes, Blackstone believes that it can boost cash flow modestly by increasing occupancy and rents and operating the portfolio more efficiently, according to people familiar with the matter. Most of the apartments are in markets that are popular with younger, single professionals and aren’t being affected by the country’s population decline.

Blackstone also believes it could achieve high returns on the portfolio partly through debt, the people said. Higher risk funds run by Blackstone often borrow as much as 80% of a property’s value. Blackstone doesn’t disclose the leverage on individual deals, but Blackstone limits its core plus strategy to 50% leverage on core plus funds.

Finally, Blackstone isn’t under pressure to boost values and sell because its lower risk funds are open ended and have no expiration date. By contrast, the riskier funds typically have a life of about five to 10 years, and pressure to sell assets and return money to investors intensifies as the end of the fund’s life approaches.

In 2014, Blackstone’s chief executive, Stephen Schwarzman, predicted its core plus business eventually could grow to $100bn. Four years later, Gray pointed out in an earnings call that “some folks laugh” at that prediction but they underestimate the “power of the franchise”.

Source: Financial News

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