by Ludovica Perazzi, Mattia Scola, and Michele Tovaglieri

Forenote

The following article presents an opinion brought forward by members of the Bocconi Students Private Equity Club. The article does not serve to publicly question the financial performance of Blackstone Inc. or its subsidiaries. The information gathered and presented in the following article was obtained from reputable sources and assembled to provide a subjective assessment of the consequences of the information on the public perception and performance of Blackstone Inc. as of March 2023. 

Introduction 

On the 2nd of March 2023, Blackstone announced the default of a $562m CMBS (Commercial Mortgage-Backed Security) secured by a portfolio of office and retail properties in Finland. The default is likely due to the rising interest rates that have affected the European real estate market by impacting property valuations. 

In this article, we will go into the details of the news by focusing on the workings of the real estate private debt market and trying to understand the reasons that led to Blackstone’s default. 

Blackstone BREDS 

Blackstone Real Estate Debt Strategies (BREDS) is a leading player in the real estate debt market, providing financing solutions across the capital structure and risk spectrum for high-quality real estate assets. Its focus is primarily on non-distressed public and private real estate debt. The division’s investment strategy is centered on providing long-term value to its investors by investing in high-quality real estate debt, while Its team of experienced professionals evaluates investment opportunities across various markets, sectors, and geographies to identify the best opportunities for its investors. 

Blackstone’s real estate debt division has a strong track record of delivering attractive risk-adjusted returns to its investors. Its investments are typically secured by high-quality real estate assets and offer attractive yields with limited downside risk. 

To better understand the potential of this division, it may be interesting to talk about Blackstone Mortgage Trust, a publicly traded commercial mortgage Real Estate Investment Trust (REIT) focused on senior loans in North America, Europe, and Australia that is part of the BREDS division. This business is well-positioned to hedge against suboptimal macroeconomic situations; in fact, the cash flows of loans are easily predictable, and the variable interest rate allows them to hedge against the possibility of rising rates. It can also be pointed out that since real estate is an asset class well-known to protect investors from inflation, the value of the underlying loans is shielded from this risk. To top it off, Blackstone’s considerable size and the experience of its advisors give its investors access to the best investment opportunities in the market with a track record of excellent risk-adjusted returns. 

As we will see, however, in the next session of the article, under extreme macroeconomic conditions with continuously rising rates and skyrocketing inflation – something can go wrong. In fact, if rates rise too much, the valuation of the properties underlying the loan decreases. The same goes for inflation: especially in the case of loans to finance real estate construction—rising commodity prices coupled with supply problems can delay the completion of the project, driving up costs. These two phenomena, combined, can make it difficult for the debtor to pay the fees by restructuring the debt to seek new contract terms that suit both sides. 

Blackstone Defaults on $562m Nordic CMBS 

In 2018, Blackstone acquired the Finnish company Sponda Oy for approximately €1.8bn. However, the acquisition process was slowed down by two years after the pandemic, which made it difficult for Blackstone to sell the assets included in the deal. To address this difficulty, Blackstone asked for an extension to the bondholders to sell the assets and repay the debt, but the request was rejected by the bondholders. The bond, issued by Blackstone and underwritten by Citigroup and Morgan Stanley, was secured by 63 buildings in Finland, but Blackstone sold about 16 of these buildings to pay off nearly half of the bond. However, it was not possible to sell all the buildings and, therefore, the outstanding balance amounted to €297.1m, according to Fitch Ratings. 

Blackstone defaulted on bonds worth €531m, secured by offices and stores in Finland. This bond was issued to finance the acquisition of the Finnish company Sponda Oy. Blackstone had difficulty selling some of the Finnish properties included in the deal, which caused a decrease in the amount needed to repay the bond. Blackstone then asked bondholders for more time to sell the properties and repay the debt, but the request was rejected. The default triggered a cross-default clause, meaning that Blackstone could face further defaults on other bonds if it fails to make payment on this one. 

This news is not the only negative event linked to Blackstone and its real estate activities. In fact, Blackstone announced that it would block redemptions from its Real Estate Income Trust (REIT) fund, a real estate fund worth approximately $71bn at the time, due to financial difficulties. In a letter to investors, the company explained that it would not be able to meet investors’ requests to withdraw funds, despite ongoing claims from the real estate fund. The company said it had satisfied requests for about $1.41bn in February, representing just over 35% of the $3.94bn requested by investors in the previous month. 

Is this an isolated phenomenon or the beginning of a Commercial Real Estate Debt crisis? 

Blackstone’s default on CMBS had multiple causes. Among these, macroeconomic ones certainly play a major role. The current situation, with the increase in interest rates desired by the FED and ECB, goes against the trend of recent years, when rates were close to zero or often even negative. Rising interest rates, especially when referring to the real estate business, have significant effects. These effects are reflected in the cost for borrowers to repay their debt, which has risen by around 300% in the last 12 months. Higher rates imply a higher outlay. But that is not all. Another factor that could have led to Blackstone’s default was the geographical proximity that the Finnish buildings that secured the CMBS had with Russia. The outbreak of war inevitably reduced the value of the properties, which had a vacancy rate of 45%.

While it is necessary to consider the particularity of the macroeconomic context in which the default occurred, to avoid excessive panic, it is useful to consider that this is not the first time Blackstone has negotiated an extension on a loan. And like all negotiations, an agreement between all parties involved is necessary. Especially in such cases, where the shareholders have the power to veto the extension.  

Certainly, the default on Blackstone’s loan is not good news for the markets, because it confirms a complicated period that has affected various players (SVB and Credit Suisse before, and now Deutsche Bank). However, the various crises seem to be isolated cases, not systemic. In fact, they are situations that are very much linked to the macroeconomic and geopolitical context that the markets are dealing with, which is heavily influenced by the policies that the central banks are implementing to reduce inflation. 

Although what happened is a serious loss for a financial institution of Blackstone’s magnitude, it should be noted that the other loans, for which an extension has been requested until May 2023, are covered by properties with a much more stable value than the Finnish offices. Consequently, it is still too early to be able to talk about a possible crisis for Blackstone or, in any case, of a possible crisis for the real estate Market. That is because, as already mentioned, the scale of events seems not to be systemic compared to 2008. Despite this, the rise in rates is having serious consequences in the real estate market: if the restrictive policies of the central banks are prolonged, it is not certain that we will not see further cases similar to that of Blackstone in a few months’ time.

Photo: Associated Press, Mark Lennihan