Chit Chat Stocks - Fake Dividends? Finding The Truth About Blackstone's BREIT With Phil Bak (Ticker: BX)

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Starting point is 00:00:43 investing. Options are not suitable for all investors and carry significant risk. Full disclosures are in the podcast description. Welcome to Chit Chat Stocks. On this show, hosts Ryan Henderson and Brett Schaefer analyze businesses and riff on the world of investing. As a quick reminder, Chit Chat Stocks is a CCM Media Group podcast. Anything discussed on Chit Chat Stocks by Ryan, Brett, or any other podcast guest is not formal advice or recommendation. Now, please enjoy this episode. All right. Welcome in, everyone. This is another episode of Chit Chat Stocks. My name is Brett Schaefer, and I'm here as always with Ryan Henderson. But we have an interview today

Starting point is 00:01:33 on our Wednesday episode, and it is Phil Bach, founder and CEO of Armada Investors. Phil, we found you because of your detailed, what I'll call maybe paper slash sub stack. We'll get into why it was supposed to be a paper, but turned into a sub stack later, but welcome to the show. And maybe for the listeners, give a little bit of a background to how you found yourself in the REIT and real estate industry for just investors in general. Sure. Yeah. And thank you. It's great to be on. The real estate space is interesting. I've been in the asset management industry for over 15 years and mostly doing ETFs. I've done some hedge fund stuff, some mutual fund stuff. And I've done a lot of factor type stuff.

Starting point is 00:02:23 And I never thought deeply about REITs. A REIT is a REIT. They're all fungible. They're all basically beta to home prices, to Kay Schiller. That's what I thought. I could not have been more wrong. But even like I say, I've been in the industry for 15 years. I think there are a lot of people like me who, despite the fact that I've been in the asset management space and thinking deeply about investing and reading about investing for so long, I just never really thought much about real estate and REITs at all. And I came to this project, I was actually introduced to it by a friend of mine named Justin Goldberg, who runs a company called Navarino Capital. And he's a real estate investor. And he said, look, he said, people are investing in ETFs,

Starting point is 00:03:04 people are investing mostly in market cap weighted funds, index funds, but even more so in real estate than they are in equities and broader asset class. And look at what they're getting. They're not getting real estate. They're getting anything that elects for a REIT. I always assumed a REIT is real estate, right? That's what it is, but it's not. It is kind of, right? But really what a REIT is, is a tax treatment. It's a tax election. And the market cap weighted funds are essentially, market cap is essentially a momentum factor. And they are increasingly becoming crowded with things like data centers, cell towers, other investments that are real estate-ish, maybe, right? A hospital or a senior housing facility. Maybe you could say it's kind

Starting point is 00:03:49 of related to real estate, but it's not pure real estate, not at all, not by a long shot. And I'd never really thought about that, you know? So I started looking at the correlations between the different subsectors within real estate. So these things are really low. They're driven by entirely different factors, right? The rate curve has a bigger impact on, you know, let's say, a heavily financed data center, right, or even housing than it does, let's say, on office, which has its own, you know, divergence now from the broader REIT group. So there was all this dislocation happening and all these different economies all kind of lumped into this one thing. I said, well, I think there might be an opportunity here to do things better, to do things different

Starting point is 00:04:27 and to do things better, to take a quantitative approach to real estate investing and to take some of the concepts that work in, you know, private market real estate investing, right, where you care very much about the geography and the location and the growth. What is the rent growth? What is, you know, if you're investing in a, you know, a lodging rate, right? You want to know what is the occupancy vacancy rate, right? But investors aren't looking at those factors. They're looking at traditional equity factors that are really designed for operating companies.

Starting point is 00:04:56 So we saw an opportunity here and, you know, we're in the early days of building something that we think is going to be the leading investment company for public market real estate. yeah so for anyone that saw the title of the episode i'm sure we're going to include the b reet uh as a little bit of a tease there we're going to get to that later maybe on the second half of the show or uh on there and you did mention office we have time at the end i do want to ask you about the office apocalypse and whether you everyone has uh thoughts on that one but first we want to talk about armada you guys launched your own etfs at armada why reach ETFs and why now? So, you know, look, when you plant a tree, right, you plant the seed

Starting point is 00:05:42 and a few years later you're bearing fruit, right? It's not a one-to-one. There are a lot of people in the ETF space that are very good at, you know, trend following and, you know, picking up on things that are hot today. I'm going to launch a fund right now into the Zeitgeist and try to grab some quick money. It's not really my personality. It's not the way I do things. You know, I think me and my partners at Armada, you know, we want to build something lasting. We want to build something that's going to, you know, work over time. And while real estate right now, you know, there might be, you know, some very legitimate, you know, concerns and reasons why people are a little bit afraid of real estate. And again, they're afraid of it broadly, but within real

Starting point is 00:06:17 estate, there are some fantastic places today to invest in fantastic areas. There are some that are still very scary. Our feeling was, hey, let's plant the seed today so that we're bearing fruit in a few years. Let's start doing those things now. And we're going to be so thankful when real estate becomes hot again, when rates start dropping, when things are going, that we've gone and we've paved the way for ourselves in advance of that. And that's what we've been doing. So we've been knee deep in data. We did a lot of testing with machine learning data. We're using REIT specific factors that, as far as I could tell, nobody else in the market is looking at. We've incorporated geographic scores.

Starting point is 00:06:56 We're like, hey, we think we could do something really unique and special here and offer it out to investors. But, you know, the fact that people are a little bit afraid of real estate, to me, that's that's great. I think it's the perfect time to build for a perfect place to build. And I think we're a lot closer to a recovery in real estate than we are to. Right. That does. I think that makes sense to me. It is like scarier to start at that moment, but it probably makes sense. You would have rather launched QQQ in 2011. I mean, obviously it launched before that than today.

Starting point is 00:07:30 You know, I'd be a little more crowded for high growth tech stuff. Well, let's talk about the two ETFs specifically you have. HAUS is the ticker. I think that's a house kind of moniker there. Why that one? What is the goal of this one? And what's your guys' strategy there? What we wanted to do here was provide pure play exposure to residentials, to the residential space, right?

Starting point is 00:07:52 So that means multifamily, single families, and REITs that provide that. It's an actively managed fund, so we have active discretion. However, we've been managing it as a pure equal weight, quarterly rebalanced, but equal weight for the last eight or nine months now. And the reason why we did that is we saw that there would be a lot of big privates, right? So a lot of these smaller public REITs in the residential space were, you know, we're getting bid on by private real estate companies. And sure enough, that's come to pass. So by going equal weight, what we've done essentially is we've overweight relative to the benchmark. We've overweight the smaller residential REITs. And, you know, I don't want to get too nerdy about this stuff. But, you know, when we talk about factors, the size factor is not observable in real estate.

Starting point is 00:08:35 There is no benefit being a smaller REIT and to being a bigger one where you have better economies of scale. So, you know, it's kind of counterintuitive that we would have gone to equal weight. But in this rate environment and with the, you know, the valuations of these REITs, we think is very depressed and very favorable that, you know, people are able to take them private at a favorable valuation. So that's worked out very well for us. But, you know, essentially we're giving people pure play exposure to the residential real estate sector. So true, pure real estate. Could you, Phil, you mentioned something there. Could you elaborate on that? You said there's no benefit to being larger relative to smaller REIT. Why is that? There's no benefit to being smaller. So the big fight between AQR and DFA, the big nerd fight that we've had over the last five, 10 years when it comes to quantitative investing is on this size factor.

Starting point is 00:09:31 Is there, in fact, a benefit to being a smaller company? Historically, smaller companies have done better than larger companies. Over the last seven or eight years, we've had this huge divergence. And I think it's best illustrated by the equal weight, the S&P equal weight versus S&P market cap weight, where you see a lot where the top names and literally the top just handful of names in the S&P have run away on a valuation level. And it's pretty much destroyed any historical premium that was observed uh by having smaller companies right so you know um dfa is saying that no there there is a benefit to being a smaller company relative to a bigger company whereas aqr is saying they're not so sure it's you know they had this great paper probably the

Starting point is 00:10:12 best name of a quantitative paper ever is size matters if you can control your junk saying that there is a size premium but only if you take out these really you know junky companies but it's very hotly debated. Now we're talking about operating companies, right? So let's say you say that, okay, small company comes in, let's take early Microsoft. They come in and they revolutionize software. And all of a sudden, they have so much room to grow. Whereas the top companies, they only have, by and large, they only have downside in front of them, right? Or that's kind of one of the concepts of it. In real estate, the larger your holdings are, It's just multiplicative, right?

Starting point is 00:10:49 You're not trying to take market share of a segment like software, right? You're just operating real estate. And there's so much of it that even the largest REIT is still a drop in the bucket relative to all the real estate that's in the country. So the question is, are there marginal efficiencies and economies of scale for the bigger guys that could help them? But there's no observable reason why this, just based on nothing else, isolating only the size of the REIT, why a smaller REIT would do better than a larger one.

Starting point is 00:11:17 Okay. That makes sense. And that is an incredible name from AQR on that paper. That's really good. Let's discuss the second one here. The ticker is R-E-A-L, which is a great ticker. What is this one? Can you go through it a little bit? Yeah, sure. Yeah. So it is our broad multi-factor real estate fund that's competing against VNQ. So whereas house is specific tactical, we're saying, hey, we're making a bet here on residentials relative to the broader universe of REITs, REAI is saying we're just going to look at anything that's a REIT is eligible for inclusion

Starting point is 00:11:54 if it hits our factor framework, if it gets allocated based on where the scores are at any given time. And it's just a multi-factor approach to try to be smarter about real estate allocations. and is the I'm thinking of you know why someone would want to buy this is it because you know typically people really the only real estate exposure they have for unless you're you know you got a little bit more money is their own house and that's one house and it's very hard

Starting point is 00:12:27 to get real estate exposure in other ways is this a way to essentially aggregate the REIT market you got data center stuff and obviously the residential one is residential only but for this one you have Data centers, commercial, industrial, residential, all packaged into one as an easy way where, say, I'm an individual, I got my retirement account, I allocate 10% to the CTF or something like that, and you get a broad-based exposure to the entire, is it global or U.S. residential, or excuse me, not residential, just general real estate market? U.S. primarily, it's a little bit of Canada in there, but it's mostly U.S. It's all North America. That's exactly it. Look, if real estate is an appropriate investment for you, you get some yield with the funds. But primarily, it's theoretically a non-correlated asset. That correlation itself is not very static. It kind of ebbs and flows like everything else in the markets. It's very much alive. There's research from Nareit that says that investors

Starting point is 00:13:30 would be better off up to 10% allocation of real estate broadly. If you personally own a house and that's a significant portion of your holdings, maybe you want to hedge. Maybe you want to go the other way and short it to even out the exposure. It depends on everyone's individual situation. But at the end of the day, for investors, there is a segment of investors for whom they're going to be allocating on a sector level or they're going to be allocating to real estate as a permanent allocation. We personally think it's more often than not a good idea. Again, it depends on everyone's individual situation. But in those instances, do you want to be allocating just blindly by market cap, which is how the passive funds work? And again, right now, the index holdings are going to be crowded out by data centers and cell towers at valuations that we think are stretched. So or do you want to have a smarter allocation that we think will work better over the long term? And that's okay. And that maybe teased my follow up question here. What do you think the best opportunity is in real estate right now? Because the last few years, it's been extremely volatile. We've seen people talk about, you know, the office apocalypse, the quote unquote potential. I don't know, there's both sides of the residential real estate equation. You know, people talk supply, demand, interest rates, unaffordability.

Starting point is 00:14:50 what what do you see what what what what is your favorite uh sector in the market right now so obviously i mean the reason why we launched house we're we're very bullish on the residential space and again you know these are rental incomes right so it's a little bit different than than the home prices broadly um but you know based on the demographics the supply demand imbalance uh you know a number of factors we like residentials i think the the space that's probably the most interesting to watch right now is very clearly office. And, you know, I wrote a post about this, you know, called Get Greedy, right? You know, the whole idea of you want to be, you know, fearful when others are greedy, you want to be greedy when others are fearful.

Starting point is 00:15:30 And people are fearful in the office space right now without a question. And they've got good reason, good reason to be fearful. I'm not calling a bottom yet, right? But we've actually gone long in REAI. We've gone long on Office a few months ago based on factors, technical factors that came up and said, and you know, there's a great quote from Jim O'Shaughnessy where he talks about like the thing he's proudest of in his career is that during the global financial crisis, he never overrode his models, his quant models, right? He stayed by the models even when he was terrified of what was happening in the markets and wanted to. This was a similar situation where, you know, we're a new company and offices are completely imploding for a hundred reasons that, you know,

Starting point is 00:16:12 make a lot of sense, honestly. Right. And, you know, the technicals are telling us that, no, there's, there's, there's a rebound to come in. It turned out to be one of our better trades. So we trusted the model, but, you know, look at the end of the day, these things aren't going to zero. They're real. They're tangible. You can knock on the door. You look at a skyline and you can see a building standing there. You know, there are some cities that are in peril, probably more than others. I think it's no secret people are leaving San Francisco and Chicago maybe to a degree as well. A lot of these office buildings have debt that has to be refinanced at higher rates. And it's not as easy as blindly just saying, all right, office space valuations are

Starting point is 00:16:52 low. Let's just throw money at it. It's not that simple. But if you can be opportunistic and strategic and patient, I think there are going to be some generational buying opportunities in the office segment over the next, I don't know, you know, I don't know if I'm talking about the next few months, the next few years, but it's coming. The bottom is going to come. And like everything else, you know, it's darkest before the dawn. These things will rebound. I can't tell you when nobody can, unless they have a crystal ball or a time machine, but that time is coming. And I think, you know, rather than just kind of, you know, write it off and say, well, you know, real estate bad and that's it. I think people should pay a little bit of attention for the signs, you know,

Starting point is 00:17:29 for the signs of a turnaround so they can get in early and not miss it. Okay. And this might be too broad of a question, but on the office discussion, are there pockets that you are seeing – are there pockets of that market that you're seeing more impacted than others? Like you mentioned some of the bigger cities are heavily impacted. Is it city versus rural office locations? Is there any sort of areas that are doing fine versus others that are really impacted? Class A is holding up significantly better than class B or class C. So the best, the premium stuff, and that's usually the case, right? The premium stuff holds up best. One of the things I mentioned that we use geographic data in our analysis,

Starting point is 00:18:13 one of the interesting things is that over the last decade, there's been very little divergence of real estate values by geography, right? We have all this data. We have a small signal there, but we don't have a huge signal. We expect that to change. We think there's going to be a larger divergence going forward based on, you know, it's called MSA, a metropolitan statistical area, like kind of a micro, you know, within cities, even neighborhoods. We think that that divergence is only going to increase over time. It seems to be the trend. So, you know, we're bullish to things that most people are bullish, you know, the South, Florida looks good. I mean, there are certain areas that certainly are higher growth than others. You can quantify that, right? You

Starting point is 00:18:53 can quantify employment growth. You can quantify rent growth. You can quantify migration trends. And you can pick out these things. But the other side of it, it's not just what's going to grow. It's, especially in this space, what is the valuation today? And there are some real deals to be had on the valuation side if you pick and choose. So it's interesting. It's a value investor's market. Yeah. And I know that Seattle, where we live, is one of the places similar to San francisco that's had a tough time but there's been some perhaps you know people have maybe taking on some risk there's some very very deep value plays there for anyone that i guess wants to learn more about the data center stuff you had a i think it was yesterday you posted another

Starting point is 00:19:37 newsletter item uh about data centers which i thought was quite good but we have to move on to one of the biggest topics of the episode the big top of the episode it's why we contacted you you had this long sub stack post that was supposed to be a paper about the REIT. Maybe a little context. I'll go from, I think this is probably a lot of the listeners as well, how I looked at the asset or the kind of the news story before I read your paper. All I knew was it was a huge fund at Blackstone. It was something in real estate. And then they were blocking people from taking money out. And then I saw the University of California made a complicated investment. So that's kind of the context I think a lot of listeners have going into this.

Starting point is 00:20:19 We'll try to explain what exactly is going on. But the first question I have is, why do you think your paper was canceled by four separate publications? A little bit of a leading one, but... Yeah, yeah, yeah. It's an interesting story. So this fund has been tremendously successful. Blackstone is a very successful firm. I mean, they're brilliant.

Starting point is 00:20:43 They've done a lot of things extremely well. And this fund especially had had tremendous, tremendous success. So, you know, like the way I got to this whole thing was, you know, just innocently, you know, OK, we're we're building some cool stuff in the real estate sector, you know, for investing. Let's do a competitive analysis. Let's see who's doing well, what they're doing. You know, and we saw Beery was bringing in four billion dollars a month at their peak. I mean, just unbelievable amounts of money. It's like, wow. Well, you know, what are they doing? Their performance was fantastic, too. And we're looking at it like, OK, we've got to really understand and let's break down what they're doing.

Starting point is 00:21:15 And as we started to break it down, more and more questions arose. And, you know, we weren't like trying to, you know, take down Blackstone or anything like that. We're just trying to understand what's going on. And as we started uncovering, we came up with some real red flags that, you know, we felt like investors should be alerted to. We, you know, we wrote a paper, right? We sent it out to to one website that we thought would be perfect for it to publish that type of paper. And they read it and they said, yeah, we're going to publish this thing on Thursday. And Thursday came and Friday came in Monday and Tuesday and another week and another week.

Starting point is 00:21:50 And it just it just never went anywhere. We didn't know why or maybe the paper is not that good. I don't know. So we sent it to another place and same thing happened. And it happened for four times in total. And, you know, you would think that the industry would have learned something from the Markopoulos incident. Right. So Markopoulos, I'm sure I'm sure, you know, most people know that Markopoulos did an analysis on on Madoff. And I'm not comparing Beery to Madoff in any way, but just this story about how he he really proved he did a cluster analysis of the style and showed that there wasn't enough liquidity in the, you know, split strike options to be able. I mean, he proved he proved beyond a shadow of a doubt that that Madoff was a fraud and he did the work and wrote the paper and nobody would give it any air.

Starting point is 00:22:33 he gave it to the regulators and nobody cared. You would think that the industry would have learned a lesson from that. Like, hey, maybe we shouldn't be dismissive. Maybe we shouldn't give people the benefit of the doubt just because they have been successful. That doesn't mean that we stop doing the basic due diligence and auditing and fact-checking that we would do for any other fund. But unfortunately, that's not the case. And we're a brand new company with very few assets and people are like, well, who are these guys? And Blackstone has been tremendously successful and they've earned the benefit of the doubt and we haven't, and they got the benefit of the doubt. So this paper got buried. And again, at first I didn't know exactly what, we came to find out

Starting point is 00:23:13 exactly how that happened. And it's pretty shocking. I think that story in itself is probably a bigger story than the fund analysis. It's not one I'm going to tell today, but it might be one I tell in the future. And it's unfortunate. You would think that in an industry where people's retirements are at stake, where real money from real people, particularly a fund like this, which has been marketed towards the proverbial widows and orphans, but certainly retirees, you would think that there'd be a lot of curiosity to this type of thing, but there isn't. And it's just the way it is. All right. New sponsor alert. This episode is brought to you by our friends at Yellow Brick Investing. Yellow Brick is an aggregator of the

Starting point is 00:23:55 best stock pitches across the internet by tracking thousands of blogs, newsletters, fund letters, podcasts, and more. They collect and summarize the best stock pitches and bring them to you in a single place. Think of it like a modern value investors club. I genuinely use Yellowbrick every single week here to try and discover new small cap ideas for the weekly power hour episodes that we do. And the best part is you get tons of features for free. Try it for yourself. Simply go to joinyellowbrick.com and search a company or ticker that you're interested in, you are bound to find a great report on just about any company. That is joinyellowbrick.com. Yeah. It's, I guess, disappointing on a couple of levels,

Starting point is 00:24:38 one being that you put so much work into it and it is, I'll just go ahead and say, go online if you're listening to this podcast and check it out because I thought the paper was fantastic. It's on the Philbock sub stack. I can't remember the exact, it's box stack is Is maybe the – what was the – Yeah, you can just go back to substack.com. You'll find it online. Link will be in the show notes. Yeah.

Starting point is 00:25:00 Yeah. But – and I'll say by the end of this, I thought it was quite conclusive, but I'm going to save that for the end of this discussion. Let's go through the B-REIT story. Tell us what it is and maybe lead us into where we are today. So, like I said, this fund had been tremendously successful. And I think in a lot of ways, what happened or where we got to today wasn't by design, by nefarious planning and, hey, we're going to screw. I think it was in large part that the fund was a victim of its own success in one sense.

Starting point is 00:25:37 In another sense, the fact that investors can't help themselves but allocate at the worst possible time when the performance is best in the rear view mirror. So you're giving money and buying into real estate at peak valuations, at peak asset levels when, you know, you really should be doing the exact opposite, but, you know, so it goes. And there are many such tales, right. In asset management, this certainly isn't the, the first one, but, but essentially you've got a little bit of a perfect storm here. You know, you've got, you know, redemptions coming at a time just when liquidity gets frozen, just when we're coming off of peak valuations of commercial real estate and the cost of capital starts to increase,

Starting point is 00:26:14 All these things happened at once. And I guess to walk people through exactly what we're looking at here, essentially you've got a fund where the value, so the NAV, the net asset value of the fund is determined not by mark to market or by where people are willing to buy or sell, but by human appraisers. And that introduces a number of problems. Humans have a bias, an anchoring bias towards their previous marks, their previous valuations. So if I tell you, and I'm paid to tell you, and I'm an auditor, and I'm paid to tell you what a company is worth, and I say,

Starting point is 00:26:50 hey, my cousin's startup is worth $30 million. I'm not lying when I come back next quarter and I say, hey, I think the market's down 10%, but I just said this thing's worth 30, kind of had that in my mind. Maybe I'll mark it down to 28 instead of marking it down where it should be, marking it down more. It's not necessarily that people are dishonest,

Starting point is 00:27:09 but there's a natural, you know, there's a natural tendency to anchor yourself to your previous valuation. The market turned very fast, faster than these appraisal appointments happen. So all of a sudden you've got public market REITs and every REIT index is telling you that, you know, commercial real estate is down by, you know, 1.35%. And this fund was down, you know, it was close to flat. You know, it still is to this day. It's close to flat. magic right now they do they do own very good properties by and large i talked earlier about the divergence between class a and class b and class c they have all class a stuff there their properties are excellent however they're not that excellent right they're not excellent enough

Starting point is 00:27:47 to overcome uh a compounding annual fee difference over 300 basis points we can talk about that um plus a 30 percent drawdown into beta i mean it's it's i'm laughing because it's laughable it's it's completely doesn't pass the smell test when you start to dig in and look at okay well how exactly, what's the mechanism here? How exactly are things happening? You find a number of other things that are, quite frankly, alarming, right? I mean, the dividends that are paid out, the dividends, they're not coming out of cash flow. They don't have the cash flow to cover the dividends, right? The dividends are coming out of dilutive shares. And essentially, you have money coming in that's going back out to pay them at this NAV level. So if you're accepting a

Starting point is 00:28:26 dividend at NAV, and we're saying that NAV is inflated by 30%, you're only getting two-thirds of the dividends that you think you're getting. But the red flag is that they can't cover the dividends with cash. If I can leave the audience with one thing, it is always be skeptical of anyone who cannot cover their dividends with cash flow, with money that they're generating. It means that somewhere there's some sort of financial engineering or shenanigans happening somewhere in the process. A business generates cash flow, they take that cash flow, give it back to the investors in the form of dividends. That's how it's supposed to work. If they can't cover of cashflow, which in this case they can, that is a huge red flag. But essentially we're talking

Starting point is 00:29:06 about valuations, liquidity, and fees are really the three things that we look into here and that we talk about and that I think investors should be very cognizant of. Okay. And let's maybe take a step back here because we talked about your REIT ETF, the HAUS, and it's sort of this pocket of the market that could do well theoretically even if everything else did poorly when we're looking at b reet what exactly is it is is there any chance that it just so happens to have completely uncorrelated returns and it's like a microcosm of a broader slowdown in real estate and it's just kind of on its own or is this a massive which i kind of this might be a leading question i already know the answer but can you just explain what b reet is and what actual

Starting point is 00:29:55 properties they own. So B-REIT owns commercial real estate across multiple subsectors and they publish that and it's across multiple geographies. We've done a study taking public market REITs and normalizing for the same subsector allocation, only class A, and normalizing as best we can for geographies, which is a little bit imprecise, but we can get pretty close to what they have. Even making those adjustments, you're still talking about evaluation diversions over 30%. 30%. There's been a couple other papers. We cited one of them in our paper, a paper that was done to normalize that. So again, even if they are the world's greatest real estate investors, and they very well might be, but even if they are the world's greatest real estate investors,

Starting point is 00:30:38 overcoming a fee difference of over 300 basis points a year, compounding over time, and then saying that, okay, we're going to be 30% above the benchmark beyond that, is it just, it defies the laws of nature. It's just not, it's not possible. Right. And correct me if I'm wrong. One of the potential issues here is that you have a NAV that's 30% higher than it should be, but you're still taking those management and performance fees at that elevated level. And then I guess to the next part of the story here, when you have the elevated level versus say you're a pension or wherever you have this allocation to B REIT, which is high, and then you have these other REITs, which have gone down in value,

Starting point is 00:31:22 well, you might want to sell the B REIT and take a redemption, right? Because that's the one that's performed best. You see it has the same assets as these other ones. And we saw a huge, you know, the redemption, I would say, I guess they didn't actually get redeemed that quickly. But people were asking for a ton of redemptions. Maybe you can go through some of the data on that. And then we can also talk about how, actually, let's talk about that first. And then we'll go to the University of California. What happened with the redemptions? And maybe you published the paper or, excuse me, it did get published. You wrote the paper almost a year ago. What has happened with redemptions from, say, the beginning of 2023 all the way to today?

Starting point is 00:32:01 So even based on their perspectives, they're allowed, they have the option to gate the fund, meaning you can't take your money out, right? There's no redemptions. But even at that level, they have to come up with 5% liquidity every quarter. And this is a fund that had $70 billion in assets, 125 something, I forgot the exact number, in real estate with leverage. So 5% of that a quarter is still a lot of money, right? They have to make some real sales. And the real estate market, the commercial real estate market for the last year and a half or so had been largely frozen. So for a while, when they first got hit with redemptions, they gated the fund. And again, that means that you can't get your money out. So they're telling you that the fair

Starting point is 00:32:38 value is here and they're going to charge management fees at that level, but you can't sell at that level, right? So it's, you know, it's not a great situation and, you know, people were unhappy, obviously. They were able to ungate the fund and now it's currently not gated. Based on the valuation difference, I mean, you know, I think any prudent investor should, you know, I mean, whatever's right for them, but, you know, you might want to consider taking your money out and, you know, reallocating into the public markets where the valuations are significantly more favorable. You can always go back, right? Once the valuations converge and historically, if you take a look at private and public real estate, they have conversion, diverge and

Starting point is 00:33:16 conversion, diverge. And, you know, it's a cycle and it's, you know, stands to reason that it would because it's not as much liquidity in the private market. But now we've converged to a level that we never have. I mean, twice as much as we ever have before. There will eventually be some sort of diversions because the properties themselves don't care what, you know, what the wrapper of the investment fund is. So they will converge. And, you know, there's no arbitrage here because you can't short uh the beread fund exactly but if you can take your money out and reallocate it then then you know probably wise to do so at least you know opt for the dividends in cash and not shares um but you know so yeah i was talking about the liquidity so when they gated the fund um they

Starting point is 00:33:56 still needed to make the five percent liquidity and that's where the uc deal uh uh the uc deal came in where they essentially incentivized UC to put cash in, $4.5 billion by guaranteeing an 11.25% waterfall, basically a preferential return stream that other people aren't getting. So this whole fund, it's kind of funny. This whole fund was like, hey, we're going to democratize commercial real estate. We're going to allow regular people to get into commercial real estate, which has been this great investment for institutional investors and has been inaccessible for individual investors for a long time. So this is the democratization of it. And sure enough, what happens as soon as the shit hits the fan, you have an institution that gets a

Starting point is 00:34:36 preferential return stream relative to all the individuals. It's not very democratic, right? But that's what they did. And essentially, they had to pay for the liquidity. They had to pay to incentivize UC to come in. And they did. And that helped them. That bought them a little time. They were able to sell a few properties. They were able to sell a few properties at the state of NAV, which is counter to what I've been saying. So, you know, they have done a few deals. But of course, in order to do that, they're going to sell their best and most desirable. You know, there are some questions as to, you know, whether the rest of the portfolio could garner those valuations. But, you know, right now the fund is not gated. There's a

Starting point is 00:35:13 Starwood fund, which is very similar, which is SRE, and they are gated now. So, you know, we're not out of the woods yet. And, you know, we'll have to see what happens. You know, if rates start to fall you know they might get saved investors might get saved which is the best case scenario you know nobody wants to see this thing blow up and it's not you know it's not a ponzi in the way that like you know an ftx was or anything like that we're not talking about that we're talking about a huge valuation gap um and that valuation gap is going to get closed one way or another it's either going to get closed by the public market catching up to where they are or it's going to you know close the other way which is you know i think we'd all prefer the

Starting point is 00:35:49 former relative to the latter. Yeah. And just to provide a little more context here, it's not the assets between the public and the private or the public REITs and B-REIT are similar. It's not as if Mr. Market was feeling down today and so the public REITs are just mispriced. There's been a true impact to the actual underlying assets due to the rise in interest rates and some other causes as well, like people working from home, not using the commercial real estate, that kind of thing. Let's talk about the dividend part here as well, because we might have some listeners that aren't that familiar with REITs. What is the promise from BE REIT to investors regarding dividends? And then why are these dividends fake? You mentioned it earlier,

Starting point is 00:36:43 but let's maybe dig in a little more. They are fake. And it goes back to what I said, where they can't cover it with the cashflow. So that's the red flag, right? They're being engineered one way or another. So with these real estate funds, when you look at them, you look at what's called AFFO, which is the adjusted funds from operations. And usually that includes fees. In this case with B-REIT, it's a little bit unique or I guess that's a nice way of saying it, but it doesn't include their fees. The fees are converted into shares. the dividends are paid out as dilutive shares. So if all the non-cash compensation of the fees was accounted for in this AFFO number, I don't want to get too into the weeds,

Starting point is 00:37:22 but they wouldn't be close to being able to cover the dividends even out of that. So it's almost like payment in kind for maybe more people that are used to public market investing, like payment in kind for a bond or something like that. It's like that in a sense where they're essentially saying, well, we can't give you the cash, but you can stick with us in the marks are high and we can keep reinvesting dividends, except it's not actually a reinvesting dividend because you don't get the cash and then reinvest because there's new shares and you're getting diluted. That's right. Right. And the reinvestment isn't going to buy real estate either. The reinvestment is going to either take out other investors or for... So it's a little bit

Starting point is 00:38:03 unusual in how it's structured. Even if the market was fine, even if the marks were fine, this would would probably raise some red flags um and it's something investors need to be aware of yeah exactly uh ryan did you have a follow-up there yeah i guess look if you were running this from blackstone's perspective you've kind of got this issue now where you've got an elevated nav and you got to keep guaranteeing returns because you've guaranteed returns for University of California and you've said you're going to give all these dividends out to all the investors. What do you do? Do you just have to perpetually keep raising money to keep filling the gap or is there a way that you can slowly wind this

Starting point is 00:38:53 down potentially without raising your money? I think the expectation, the hope and even the expectation is that rates are going to come down and prices are going to recover and that'll kind to get everyone out of this mess. And that might be so, but even still, if valuations catch up to where the NAV is now, that means that you're essentially not getting the future return that you should on that balance, right? Your forward returns are already, you borrowed from the future from your returns. But I think there's a big expectation of that. If that happens, maybe they can sell properties and raise cash. And again, buy a little time. They can be creative in other ways. Look, they're very good at raising capital, right? Blackstone is probably the best in the

Starting point is 00:39:38 world at that. And maybe they can IPO the whole thing. There'll be a significant NAV drawdown. There's a private market exchange that's trading private market REITs now. And so trying to kind of set the market and see where it is. And I think they've got some bids at about a 15% to 20% discount to NAV right now. So not as bad as we think it is. And maybe they IPO the fund, They take that hit right on day one. But now it's a public market read. That's something a little more creative that they can do right now. All indications seem to be they want to raise new money into the fund and they're out. They're talking about the performance of the fund is a reason why investors should invest. Right. The performance is what they're using to raise new money.

Starting point is 00:40:19 But the new money can then offset the redemptions. And essentially, you're just buying time and kicking the can down the road, you know, and then hoping that there'll be a day when rates become favorable and prices recover so they can get themselves out of this mess. Yeah, I was going to say, it sounds like what you're talking about is they can, what's the term, pretend and extend this problem. But if you were Blackstone, wouldn't you want to try to not just extend this gaping hole?

Starting point is 00:40:53 Well, Ryan, then fees come down. I'm in. We want fees to go higher. That's what they're incentivized to do. I was going to ask about Blackstone, the public company. You mentioned how much of the fees this makes up. How could this come back to them? Is that incentive there kind of part of the problem where it's tied to this public company stock that earns all these management fees and a lot of them come from beat read? Finchat.io is the complete stock research platform for fundamental investors. They have all the standard financial data on more than 100,000 stocks globally. But beyond that, they have company-specific segment and KPI data on 1,800 stocks. Want to see NVIDIA's data set

Starting point is 00:41:30 and revenue? FinChat's got it. Like to track Spotify's premium subscribers? They've got that too. And they just added ETFs to the platform as well. The breadth of FinChat's data is truly one of a kind. We use FinChat every day, and I've personally been using the AI co-pilot more and more to summarize earnings calls and conference transcripts. To get 15% off any paid plan, go to finchat.io slash chitchat. That is finchat.io slash chitchat. To get 15% off any paid plan today, the link is in the show notes. Earlier in the show, you heard us talk about the investing platform public.com. That's where you can trade options with no commissions or per contract fees, and you get a rebate of up to 18 cents per contract traded. NerdWallet recently gave public

Starting point is 00:42:18 five out of five stars for options trading. If you want to see why, go to public.com and start getting a rebate of up to 18 cents per contract traded, paid for by public investing options, not suitable for all investors and carry significant risk. Full disclosures in podcast description, US members only. It's material. It's material to Blackstone. It's about roughly about 15% of Blackstone's revenue historically. Now, there's a lot of variability, a lot of contingencies there. There's a significant carry, so performance fee with a hurdle rate and B-read and depending on the year, some years it's been worth a lot, some years less so. So it's not exactly apples to apples, but it's very material to Blackstone. I think on a reputational side,

Starting point is 00:43:00 it's even more so. And the other thing that they can do to get out of this mess sooner rather than later is to sell properties at the state of net and to sell big properties and a lot of them and really create some liquidity for themselves and for their investors that way, if they were able to get their NAV price, they would no doubt do so. So I think the fact that the deals have trickled is indicative of what we're dealing with here. But the worst case scenario, which is not a sure thing at all, but the worst case scenario is a liquidity death spiral where investors are spooked and they start running for the exits again. BlackRock has to gate. They have to mark down the NAV. They have to sell properties by selling properties. They mark down the NAV

Starting point is 00:43:46 further. Investors get even more scared to redeem more and on and on and on. And you get to this liquidity cycle that's possible. There's a non-zero chance of that. I don't think that's the only possible outcome. I'm not saying that it's guaranteed to happen, but it is a possibility depending on how things play out. Is there any situation where, or is there a term where they have to they're no longer able to gate redemptions like after two years or something like that do they have to let everything come out or can they just keep going five percent a quarter for i don't know what that would be 20 quarters yeah i i believe i'm not 100 but i think they can they can do it and i don't remember seeing a a time limit but again you know five percent is still

Starting point is 00:44:33 a lot of real estate to sell order so you know yeah exactly and as we maybe go out of the details here into the more broad you know idea of the b reed structure do you think this structure is just not maybe logical rational because it seems to me like you promise liquidity but you're in illiquid assets. And that makes more sense for a limited partnership, private equity vehicle, something like that. Is that your thinking here or am I looking at it the wrong way? I think you're right. Look, I think it's great for permanent capital. This idea that private market real estate is more desirable than public market real estate, I think there's a little bit of mythic to that. There's this idea that they're not different things. They're all the same thing.

Starting point is 00:45:33 You can have different class levels. You can have different quality of real estate. But the fact that a real estate is publicly listed is not inherently bad. And there has always been this concept of liquidity premium. And that means that the more liquid something is, the more you're willing to pay for it because you get that liquidity. It's good. It's valuable. Nobody thinks about liquidity in the up markets. It's when the shit hits the fan that liquidity matters. nobody thinks about it until the last minute. And over the last few years, a miraculous achievement of sales and marketing and financial services industry, where that whole concept of a liquidity premium has flipped. And there is now an illiquidity premium, right? People think like,

Starting point is 00:46:11 ooh, it's illiquid, it's private, it's so much better. Anybody could just go buy an ETF, but hey, this is liquid stuff, ooh, right? Only I have access to it. And it's so absurd. It's crazy because people are paying more, they're paying a higher fee for less liquidity. That might make sense in a world where the valuations on the private stuff is so low, you can go and source deals so well, or you can have some sort of edge that makes up for it. But at the end of the day, investors have over the last, really since the global financial crisis, and since we've been flooded with money by monetary and fiscal policy, people have really discounted the need for liquidity. And that too is not a permanent state. People are going to remember, and they're going

Starting point is 00:46:50 remember through hard lessons that liquidity matters and liquidity is valuable. I love the idea of taking private market real estate and making it available to investors, to all investors, democratize it. I love that concept. I think it's great. And I think there's a place for it, but it has to be done in a way where either people understand and know that the capital is permanent capital, where the valuations are fair and the fees are fair. And ultimately that there are protections from situations like this. It hasn't been solved. Yeah. I think you mentioned it in your write-up that the smoother return stream of illiquid real estate or these private REITs is not only, I can't remember who said it, not only a feature

Starting point is 00:47:35 of the private markets, but it's the major selling point for a lot of these funds. Yeah. Yeah. And that extends beyond real estate. That's all private equity. And in some cases, VC, where the marks are less frequent. And like I said, for a bunch of behavioral bias reasons, tend to be less volatile than they are when people are voting with their dollars in a marked market sense. and it creates a smoother return stream. And look, anybody, you know, any financial analyst should be aware of the smoothing effect and should know how to solve for it and compare these things apples to apples. But we're still seeing a lot of private equity firms,

Starting point is 00:48:15 you know, not necessarily Blackstone in this case, but we've seen other private equity firms selling on an apples to apples comparison of standard deviation of, you know, a quarterly marked or even annual marked private equity basket relative to daily marked market public securities. And it's a completely unfair and dishonest comparison.

Starting point is 00:48:33 You know, hopefully investors can wise up to that. Okay, that makes sense on the illiquid versus liquid mismatch. I guess we have a few wrap-up questions. My first one, and you can answer it or not. What do you think the worst thing that Blackstone did? And do you think they acted unethically? I think it's, you know, it's a tough question. I think the answer to both is the same. I think the sin here, if there was a sin, was hubris. You know, and we've seen this in this industry over, you know, as long as it's the same story where success breeds hubris and hubris breeds disaster. And I think they had a lot of success for a lot of the right reasons.

Starting point is 00:49:19 They had a great fund, great company, great people, and they had a lot of success. And I think it led to hubris, and I think hubris led to the situation. All right, final question. In a broader sense, for any listeners here that want to learn about the real estate market, what do people most misunderstand about real estate? And then maybe tell listeners where they can find you. I, you know, that's a really interesting question, because I would say that people who invest in real estate, right, directly private, private market real estate, you know, need to really have a lot to learn from the public market investors, right? A lot to learn about correlations and beta and, you know, cyclicalities. And, you know, everyone knows, obviously, there's, you know, there's a component of beta is a lot of leverage in the private real estate world. But I think there are a lot of lessons and metrics that can be learned.

Starting point is 00:50:12 And on the public market side, there's a lot to learn from the private market real estate guys. The way they look at NOI and cap rates, the way they look at AFFO, the way they look at geographies and different data, it's different. It's different than what public market investors are used to looking at. And I think between these two worlds, that bridge between these two worlds is where, you know, is where we live. And we're trying to educate both sides to the other and find ways to kind of, you know, bring signals and opportunities and, you know, kind of mash those two worlds together. That's what we're doing at Armada. And I think that would be my advice to the investors from both sides of that bridge. All right.

Starting point is 00:50:47 You can find them on Twitter, Substack, or Armada Investors. Let's get it right. ArmadaInvestors.com. all three of those links will be in the show notes. Phil, anything else before I hit our disclosure? That's great. Thank you guys. Really enjoyed the conversation. All right. Beautiful. As a reminder, we are not financial advisors. Anything we say on the show is not formal advice or recommendation. Ryan, I, or any podcast guests may hold securities discussed in this podcast, may have held them in the past, and may buy, sell, or hold them in the future.

Starting point is 00:51:20 Thank you everyone for tuning in, and we'll see you next time. We'll see you next time.

Chit Chat Stocks - Fake Dividends? Finding The Truth About Blackstone's BREIT With Phil Bak (Ticker: BX)

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