A Real-Estate Fund Industry Is Bleeding Billions After Starwood Capped Withdrawals

Starwood Capital Group’s move to severely tighten restrictions on investor withdrawals from its $10 billion real-estate fund is rippling through the $90 billion private real-estate fund business.

After the giant investment firm announced the new restrictions in May, sponsors of similar funds said they experienced a jump in redemption requests. Investors in these funds, mostly individuals who paid as little as $2,500, appear worried that their funds might also tighten the withdrawal spigot, forcing them to wait indefinitely in line if they want to cash out.

“When Starwood started cutting redemptions, the first thing you think about is: what’s my guy going to do,” said Kevin Gannon, chief executive of Robert A. Stanger, an investment bank that specializes in real-estate funds. “There’s a natural knee-jerk reaction.”

Some firms indicated that withdrawals are already stabilizing. Blackstone, the sponsor of the largest fund, said that June redemptions fell and were slightly below the level of withdrawal requests in April. That marks an improvement after investor redemptions rose in May following Starwood’s announcement of its new limits.

Still, there is widespread industry concern that Starwood’s move may have a long-term negative impact on investor sentiment. “How it could sour investor appetite is our biggest risk,” said David Steinbach, global chief investment officer of Houston-based Hines, which manages a $2.6 billion fund.

Stanger projects that investors will redeem $16.5 billion from the funds this year, compared with $1.5 billion in 2021. Meanwhile, new fundraising is expected to dwindle to $5.7 billion this year, compared with $34 billion in the funds’ peak year of 2021, Stanger said.

The shrinking fund business is one of the most dramatic signs of the commercial-property downturn caused by the jump in interest rates and flagging demand in the office sector. Investors who enjoyed outsize returns when real estate boomed have lost money in recent months as property values have fallen.

Some fund sponsors, including Blackstone and KKR, started limiting investor redemptions more than one year ago to 2% of the total value of the fund’s assets a month, or 5% a quarter. Earlier this year, it appeared that the industry was turning a corner when Blackstone said that its $60 billion fund had once again started meeting all redemption requests.

But Starwood’s move signaled the storm was still raging in the real-estate fund business. Facing a cash crunch and not wanting to increase leverage or sell property into a weak market, Starwood went further than any other fund by restricting monthly withdrawals to 0.33% of net asset value.

“Further leveraging the vehicle or selling our portfolio’s assets to meet monthly redemptions would negatively impact all investors,” Starwood said in an emailed statement.

Blackstone’s fund felt the repercussions immediately. Firm officials said that in the first half of May, investors were redeeming funds at the same pace as April. After Starwood’s announcement, withdrawal requests increased, they said.

Redemptions in the fund in May were about $1.6 billion, compared with about $800 million in April, according to filings.

“There’s been some news based on this [Starwood] dynamic,” Jonathan Gray, Blackstone’s president, said at an investor conference in late May. “That creates some increase in redemptions, but nothing like what we experienced back in the beginning of 2023.”

With redemptions greatly exceeding fundraising, the total asset value of the funds has fallen to $90 billion from their peak of close to $110 billion last year, according to Stanger. “It will be the middle of next year before they’re raising more than they’re redeeming,” Gannon predicted.

For Wall Street firms, the reversal of fund flows has been painful. Selling these types of funds to individuals at such a large scale has provided a relatively new source of fees for firms that traditionally have sold to institutional investors.

These funds were designed to appeal to individual investors by giving them the ability to redeem their shares on a monthly or quarterly basis. Sponsors disclosed to investors that the funds retained the right to limit redemptions to avoid being forced-sellers. But they were marketed by financial advisers and others who stressed their liquidity.

Some financial advisers question whether individual investors’ appetite for the funds will return, even when the commercial real-estate industry rebounds. “I suspect it will be hard to get that amazing fundraising again,” said Allan Roth, founder of Wealth Logic, a financial-planning firm based in Colorado Springs, Colo.

KKR in June responded to the high redemptions in its $1.2 billion fund by investing $50 million in fresh capital and promising to cancel $200 million worth of the firm’s stake in the fund if its share price, at $25.56 on May 31, doesn’t hit $27 in three years. “We have confidence in a real-estate recovery,” KKR said in a letter to shareholders.

Blackstone said the increase in shareholder withdrawal requests following Starwood’s action in May exceeded the 2% monthly limit.

But the fund’s board decided to honor all redemption requests anyway, thinking the increase was an aberration.

In a letter to investors in June, Blackstone emphasized that the fund had no plans to change its share-redemption program. It also noted several bullish trends in the commercial-property market, such as increased availability of debt and declining new supply.

“Now is a time to look past the headlines,” the letter said.

Write to Peter Grant at [email protected]