As redemptions in the nontraded REIT market show no signs of abating, KKR’s announcement earlier this week that its management would commit to subordinate up to $200 million of its investment in KKR Real Estate Select Trust (KREST) to support an NAV of $27.00 by 2027 represents the latest move by a major sponsor in the space to staunch the exodus of retail investors. It also shields investors from share value declines of up to 16%, while also providing $50 million of fresh capital to the REIT to meet redemptions and address other issues.
It probably is the most far-reaching effort by a nontraded REIT sponsor since liquidity and redemption problems in the space began in early 2023. Blackstone has negotiated outside investments and sold assets to meet redemptions at its $59 billion BREIT and Starwood has slashed redemptions and lowered the management fee on its $10 billion SREIT vehicle. However, KKR is the first sponsor to deploy its own capital.
Given that other nontraded REIT issuers are likely to experience their own redemption issues, it remains to be seen what other tactics different players in the industry use to address the redemption problem. So far it seems that nontraded REIT issuers are willing to try any number of strategies—except lower their NAV (net asset value) significantly.
KKR's solution is complex and unprecedented, according to Robert A. Stanger & Co. “Affiliates of KKR have pledged that if NAV Per Share is below $27.00 on June 1, 2027, they will cancel up to 7.7 million shares of KREST they own to support a NAV Per Share of $27.00. If cancellation is insufficient to bring NAV Per Share up to $27.00, all such 7.7 million shares will be cancelled," the investment bank wrote in a research note. "The value of any cancelled shares will accrue to the benefit of existing shareholders at such time, giving them a preferred priority return over KKR affiliates. In addition, affiliates of KKR will inject $50 million of new capital into KREST pari passu with shareholders (the associated shares issued would not be part of the 7.7 million shares subject to cancellation). KREST indicated that it intends to maintain its annualized gross distribution per share of $1.56 over the course of the preferred return period.”
At $1.2 billion in assets, KREST is relatively small, at about 12% of the size of SREIT, and less than 2% as big as BREIT. This makes it easier for KKR to support KREST with its own capital. Between them, Blackstone and Starwood manage more than 70% of the assets invested in the nontraded REIT space.
“This move insulates KREST shareholders from a 16% decline in NAV while providing KREST with $50 million of added liquidity on top of its robust liquidity sleeve and financing capacity estimated at 28% of NAV already,” stated Kevin T. Gannon, chairman and CEO of Stanger. “This is a smart and bold move to offer enhanced downside protection for returns that has the potential to reignite fundraising at KREST.”
The current generation of nontraded REITs were introduced by Blackstone in 2017 and were designed to offer investors similar access to the real estate market as institutional investors with limited liquidity and without the volatility of publicly traded REITs. With interest rates on Treasury securities in the pre-pandemic offering 0.5% to 1.5%, nontraded REIT shares paying out 4% or 5% were an instant hit with income-oriented investors.
As many asset classes within real estate boomed during the pandemic, nontraded REITs saw their shares soar 25%, 30% or more in 2021, according to one analyst. A handful of investors took profits that year, but redemptions were not a problem for the sponsors. For the sake of comparison, the Vanguard Real Estate Index ETF, VNQ, representing publicly traded REITs, climbed 40.5% in 2021, according to Morningstar.
The world changed for most real estate assets changed dramatically in 2022, when the Federal Reserve began raising interest rates at the fastest rate in modern history. Vanguard’s index-based ETF fell 26.2%. Blackstone’s BREIT managed to climb 8.4% in 2022 and rose more than 30% in 2021. According to the firm, BREIT’s I share class suffered a modest 0.5% decline while the nontraded REIT group average stood at negative 6.07%.
The discrepancy raised eyebrows about the accuracy of valuations in the entire private REIT space—and Blackstone in particular—even though many sophisticated observers accepted the intrinsic and sometimes excessive short-term volatility of publicly traded REITs, which some analysts argue trade like small-cap value stocks. However, private REITs, designed to offer risk-averse investors a reprieve from wild stock market swings, are facing other challenges as well.
Income-hungry investors infatuated with 4% or 5% yields in the pre-2022 era suddenly enjoyed an array of income options, from money-market funds and CDs paying 5% to junk bonds paying 7.5% or 8.0% to BDCs (business development companies) yielding 9% to 10%. That’s one reason some like Gannon expect net capital outflows for nontraded REITs to continue into the middle of 2025.
Even if that imbalance resolves itself, many sectors of the real estate market face other structural problems. Interest rates exceed cap rates, or the expected return on a property based on the income it is expected to generate, on most properties. In normal market conditions, the reverse holds true. Until the real estate and fixed-income markets return into balance, problems with liquidity and valuation are likely to remain.