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Equity especially real. estate. In 2010, the size of the global real estate private Equity Market was 68 billion dollars. By 2021, this had more than doubled to 176 billion.

After 10 years of low interest rates in an increasingly volatile stock market, large institutional investors like Pension funds and endowments have turned to private real estate as a method to achieve reasonable returns without the risk and volatility associated with the stock market. Firms like Blackstone and BlackRock make billions of dollars in fees by managing these funds. Even during the volatile markets of 2022, it looked like things were going well. Blackstone's Flagship Private Real Estate Fund posted a gain of nine percent.

even when publicly traded REITs had declined by more than 20 percent. But in December the House of Cards started to show cracks Blackstone froze withdrawals, meaning that many investors weren't able to take their money out. Having a nine percent return doesn't do you much good if you can't spend the money. And this wasn't an isolated incident.

Just a month later, another massive asset management firm called BlackRock halted withdrawals on its 4 billion. UK Private Real Estate Fund. Perhaps more concerningly is the fact that on average, private real estate funds have significantly underperformed their publicly traded peers for every one of the last four decades. Yet, large pension and endowment funds continue to sink more and more money into this black hole lining the pockets of the fund managers at the expense of stakeholders.

The ultimate victims are the public employees such as school teachers, firefighters, and police officers. The U.S is facing a pension crisis with Public Employee Pension funds lacking the assets to cover their expected liabilities. This is in large part due to the perennial investment underperformance. According to a study published in the Journal of Portfolio management, 98 of U.S Pension funds underperform their respective passive indexes over a 10-year period.

This has massive implications for the next generation of retirees who may not receive nearly as much as they expect from their pension plans. This video will be split up into three parts. Firstly, we'll look at why Blackstone and BlackRock halted withdrawals. Second, why private real estate funds consistently underperform public Alternatives and most importantly, wide pension and endowment funds continue to sink money into them regardless.

To understand what's going on with Blackstone and BlackRock today, we have to understand how private real estate fund is structured and why they exist in the first place. Let's take the example of a pension fund for public employees such as teachers. Every month, a portion of the teacher's salary is deducted as their pension contribution. The Mandate of the pension fund is to invest these contributions such that they can grow as much as possible once the teachers retire.

This way, the teachers can enjoy a comfortable retirement even if they didn't save any of their own money. The pension fund is run by a committee that is tasked with deciding how to invest this money, which can add up to tens of billions of dollars. For large pension plans, they have A few different options. They can invest in the stock market.

With the S P 500 having returned about 10 per year over the last century, that looks like a pretty good deal. The risk is that you can get a year like 2008 where the stock market declined by almost 40 percent given the risk. Pension Funds are generally not willing to put a large percentage of their portfolio in common shares. They could also invest in government or investment grade bonds.

These are much safer, but you might only make a two or three percent yield not enough to fund their pension obligations. A middle ground is real estate. Both residential and commercial property generally offer rental income far in excess of government bonds. Additionally, real estate prices are generally far less volatile than the stock market.

The problem is the Pension funds Investment committee has nearly the expertise nor the bandwidth to buy properties directly. This is especially true for large Pension funds with billions of dollars to deploy, as that could fund the purchase of hundreds of buildings. So instead of buying up hundreds of properties directly, they instead turn to Wall Street for help. Private Equity Firms like Blackstone and BlackRock will invest the money on the pension fund's behalf.

The private Equity Firm pools the capital for many different Pension funds and other large investors and uses them to buy large properties. They identify which properties to buy and manage the portfolio by. Outsourcing the investing decisions to the Private: Equity Firm The Pension Funds investment. My committee basically doesn't have to do any work.

In theory, this sounds like a good system. The investing decisions are deferred to experienced professionals who can manage the portfolio far better than the pension's investment committee. And if the private Equity Firm is doing their job correctly, the value of the properties should increase over time, giving the pension fund a nice gain once they pull their money out. One of the most successful private Equity firms is Blackstone The Crown drooled their business as their 126 billion dollar private real estate fund called B Re.

The fund was having a great year in 2022. By the fourth quarter, they were up nine percent year-to-day given the high returns. Many investors tried to pull their money out to lock in the games, but there was a problem. The real estate fund does not hold a lot of cash.

most of its capital is tied up in real estate. If a lot of investors withdraw at the same time, they would be forced to fire sell their properties, which would likely end up getting them worse prices. To prevent this, they create a withdrawal limit. Each month, only two percent of the funds assets under management are allowed to be withdrawn, and in each calendar quarter, a maximum of five percent of funds can be withdrawn.

In December of 2022, this threshold was exceeded, so most investors were not able to withdraw. But why would so many investors want to withdraw at the same time? the real estate sector didn't have a great year in 2022. Rising Interest rates, as well as recession fears caused the Ishare's core Us re-etf to decline by roughly 25 percent. REITs Or Real Estate Investment Trusts are publicly traded companies that own and operate real estate.

They basically do the same thing as a Blackstone private real estate fund, with the only difference being that they are listed on a stock exchange. So how is it possible that Blackstone's fund did so well when the broader Reit sector did so poorly? It's possible that Blackstone's employees are extraordinarily skillful. They manage to choose properties so good that they continue to increase in value even when the rest of the industry is declining. But there is also another much more plausible explanation: Stock prices are determined in real time by millions of buyers and sellers in the marketplace.

The share price of a publicly traded Reit is determined by whatever price people are willing to buy and sell it for. Investors, look at a huge range of factors when deciding how much they're willing to pay for a stock. This includes the current performance of the underlying company as well as the future expectations of the company's prospects and other investment opportunities. With the Federal Reserve increasing interest rates, government and corporate bonds alike became more attractive to investors.

Many of them started selling their positions in REITs to buy bonds instead. Also, many people feared that rate hikes could cause a recession. in 2023, they sold their read shares in anticipation of this. Because of this, Reit stocks declined substantially in 2022, despite the fact that the rental market was still strong.

Private real estate funds are not listed on the stock market, so there's no way to directly observe their value in real time. So instead they use appraisers to estimate the value of each property that they own. They add all these together and subtract debt to calculate the net asset value or nav of the fund. The appraisers may consider factors including rental rates, occupancy rates, and recent sale prices of similar properties in the area to come up with valuations.

By Blackstone's own admission, appraisals of property are inherently subjective, and the estimated nav may not accurately reflect the prices that the properties could achieve if they were liquidated on any given day. Blackstone's nine percent return was calculated based on the appraised value of the properties. Had the same real estate been publicly traded as a re, the market price would likely diverge significantly from net asset value. Let's take the example of Boston properties, a publicly traded read that owns mostly commercial real estate in Boston as well as other cities.

During 2022, the share price was hammered Falling by almost 50 percent. Despite the poor stock price performance, the company was still profitable during the year and its Book value increased from from 51 dollars per share at the beginning of the year to 53 dollars per share by the end of the third quarter. The book value is roughly analogous to net asset value. During the same period, they also paid about four dollars in dividends, which translates to eight percent of net asset value.

If you were a shareholder in Boston properties, you could delude yourself into thinking that you made a positive 12 return on your position based on the increase in Book value and dividend. But of course, this would be delusional. If you want to access your investment returns, you have to sell the stock and recognize the laws. It doesn't matter what the book value is, it only matters what someone else is willing to pay you for it.

That's the exact same problem that Blackstone is facing. They say the properties they own are worth 126 billion dollars, but if they were to sell them all today, they wouldn't be able to receive 126 billion dollars. This is why they have to Halt withdrawals. And this is not just a problem with Blackstone it's endemic across the entire private Equity industry.

During times of session or economic uncertainty. Real Estate Investors Become nervous and have a lower willingness to pay for any given property, even if rents are high today. If there's a recession next year, a lot of your tenants may go bankrupt and the rental income will decline. But the recession hasn't happened yet, so current rent numbers are still strong.

The recession fears are almost immediately reflected in the value of the publicly traded reads because Shares are changing hands every day, but the appraiser of a private real estate fund may not include this in their appraisal. This can give the illusion of the private real estate fund outperforming, even if the properties they own are substantially similar to the properties owned by the publicly traded reads. But of course, this charade can't last forever. Eventually, the properties are sold and the money is returned to the pension and endowment funds.

So instead of looking at the performance in any given year, the only valid comparison between public and private real estate is long-term performance. According to the asset management firm, Schroeders Publicly Traded, REITs in the U.S significantly outperformed private real estate funds in every one of the past four decades. On average, the Ftse Index of publicly Traded U.S REITs generated an annualized return of 12 from 1980 to 2019, including dividends. The equivalent index of private real estate has only returned 8.7 per year during the same period.

This 8.7 percent is gross of fees. A typical private real estate fund charges a roughly two percent annualized management fee. Subtracting this gets you 6.7 annualized returns roughly half of the returns for publicly traded reads. Given the long investment Horizons of Pension funds, this difference compounds on itself and can have a huge cumulative impact.

Had you invested one thousand dollars into the Ftse re-index in 1980., this would have turned into more than ninety thousand dollars in 2019. Had you invested in private real estate funds, it would only be fourteen thousand dollars. This is a difference between having a comfortable retirement and barely scraping by. This all begs two questions: Firstly, given that private real estate funds and publicly traded REITs generally own similar assets, why have private real estate funds exhibited such extreme underperformance, And secondly, given their inferior returns, why are Pension funds still increasing their allegations to private real estate? There are a couple of reasons.

Firstly, publicly traded REITs tend to take on more leverage than private real estate funds. This is in part because they have access to public Equity markets on a liquidity crunch. They can raise funds by issuing more shares. This makes them a safer investment from a lender's perspective and thus allows them to sustain higher levels of Leverage.

Secondly, publicly traded REITs tend to invest more in development projects as well as Niche properties like hospitals and Laboratories these types of Investments tend to have higher rates of return, but are harder to liquidate than more traditional types of. Real Estate Investors Don't really care if the reads assets are illiquid because the shares themselves are liquid. If you own shares in a hospital, read: it doesn't matter. The hospital itself is difficult to sell.

You can just sell your shares in the Reit instantaneously. But perhaps the most interesting explanation for the outperformance of Reads is that their share prices tend to trade at a discount to their net asset value. This means that you can buy shares of Freeze for a lower value than the estimated value of the properties they own. All else equal.

The lower the valuation of an asset you buy, the greater will be your returns. If you invest in the Blackstone fund or any other private real estate fund for that matter, you have to buy in at Nav. Given that Public Reads tend to offer more attractive valuations Superior liquidity. And historically Superior returns.

why do Pension funds and endowments continue to pour billions of dollars into private real estate? While lack of liquidity is generally viewed as a Bad Thing, some investors may actually prefer it. Because the Blackstone rate uses Nav appraisals to calculate returns, it appears to be very stable. With the exception of the pandemic in early 2020, there were no major drawdowns for comparison. Boston Property stock showed extreme volatility during the same period.

Of course, the nature of Blackstone's property portfolio is different from that of Boston properties, but the point is just by the nature of how value is calculated, the returns of private real estate almost always appeared to be less volatile. Pension Funds may be attracted to the apparent smoothness of private real estate returns, even if this has no bearing on economic reality. But how could Pension funds be fooled by such a simple gimmick? Given that U.S Pension funds control hundreds of billions of dollars in aggregate, you would expect them to be run by highly experienced professionals. But unfortunately, this is not the case.

According to data compiled by Bloomberg, the majority of Pension Fund board members are Pension Plan beneficiaries, often working on a part-time or even volunteer bases. For example, a pension fund for public school teachers may have an elementary school teacher sitting on its board. The thinking is because it's the teacher's money. The teachers themselves should have a saying how it is invested.

The problem is, these people often have little or no professional investing expertise. This makes Pension Funds a fertile hunting ground for slick Wall Street sales people who can easily sell their High fee private Equity solutions to these unsophisticated targets. That's not to say all private Equity Solutions are bad. It's possible that the Blackstone private real estate fund is outperforming the market, but we have no way of confirming this because the reported Nav is disconnected from what the properties would be worth in a hypothetical sale.

Some private real estate funds will do better than others, just like some public REITs will do better than others. But the poor average returns have contributed in large part to the fact that 98 of Pension funds underperformed their passive benchmarks over a 10-year period. And it will ultimately be the retirees that pay the price. Alright guys that wraps it up for this video: Do you think the Pension funds should invest in private? Equity Or should they stick with the more transparent, publicly traded? Securities Let us know in the comments section below.

As always, thank you so much for watching and we'll see in the next one. Wall Street Millennial Signing out.