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Joy to the World

Recently, in a column in Financial Planning magazine, I suggested that the only people who would recommend non-traded REITs to their investment customers were brokers or dually-registered reps who are paid a generous commission to do so.

Now, in the first few months of the year, we'll see if I'm right. Blackstone Real Estate Income Fund II (the primary registration document can be found here: is raising capital sans commissions. It was designed, according to media reports, to appeal to fee-only advisors–and the premise seems to be that the only reason fee-only advisors weren't selling these products like hotcakes was the commission structure attached to them. If I'm wrong, then as you read this, fee-only advisors are jumping up and down in jubilation at, finally, getting their hands on a non-traded REIT they can recommend to their clients.

I haven't read a limited partnership prospects in many years, so I went back to look at the REIT's registration offering to see how appealing the deal structure would be to a real fiduciary who is looking out for the best interests of his client instead of his wallet. The summary indeed states that the shares will not be subject to a sales load. However, on page 13, and again on page 68, we find:  

The Fund pays the Distributor an ongoing fee (the “Distribution and Service Fee”) at an annualized rate of 0.25% of the average net assets of the Fund. The Distributor may pay all or a portion of the Distribution and Service Fee to the selling agents that sell Shares of the Fund. Payment of the Distribution and Service Fee is governed by the Fund's Distribution and Service Plan. See “Subscription for Shares-Distribution Arrangements” below.

The Investment Manager and/or its affiliates may pay additional compensation, out of its own assets and not as an additional charge to the Fund or the Master Fund, to selling agents in connection with the sale and/or distribution of Shares or the retention and/or servicing of shareholder accounts.

Won't this money ultimately come out of the pockets of investors?

On page 19 of this fee-only fund, and again on page 68, we are told that the "maximum sales load" is 2%. Later, the prospectus tells us that money is being paid to broker-dealers to handle the distribution of these shares. Are they being handed a commission that would otherwise have been paid to the fee-only advisor?

The fund plans to invest its assets in the Blackstone Real Estate Income Master Fund, which appears to be a pooled portfolio of mortgage and real estate loans that various other Blackstone programs (including, presumably, those sold at commission) are conduiting the money they raise into. The program's expense ratio, cited on page 4, is 1.5% of "Master Fund's Managed Assets," which sounds harmless enough, until you realize that this is quite clearly not saying 1.5% of this particular investment program that participates in the master fund, but the master fund as a whole.

Really? I looked for clarification and found this:

In light of the Investment Manager's arrangements with the Master Fund and the fact that the Fund will seek to achieve its investment objective by investing substantially all of its assets in the Master Fund, the Investment Manager will not charge the Fund a management fee with respect to any period during which the only investment security held by the Fund is that of the Master Fund. As a result, as long as the Fund continues to invest in the Master Fund as part of a master-feeder arrangement, shareholders will incur a single fee for management services provided by the Investment Manager to the Fund and Master Fund (without duplication).

Okay, that's pretty opaque. To make things even more confusing, several places in the prospectus, we are told that the fund may incur up to 50% leverage. The 1.5% seems to relate to the total assets being managed, not the money that was raised or the actual investor dollars. This was an old trick first pioneered by the tax shelter boys back in the 1980s: borrow money, and then charge investors not just for the money you raised, but also for the money you borrow.

There is also an incentive fee equal to "15% of the amount by which the Master Fund's Net Capital Appreciation for each Fiscal Period (as defined below) ending within or coterminous with the close of such fiscal year exceeds the balance of the loss carryforward account, without duplication for any incentive fees paid for such fiscal year." Several paragraphs of fine print later, I'm still not sure exactly how this is calculated, although I was able to discover that the fund's fiscal year ends October 31.

And then there are the operating expenses that the program incurs on behalf of its investors. These are laid out in some detail in the prospectus–and I especially like the "including but not limited to" phrasing. I'm willing to bet none of you will read this in its entirety, but if you do, I promise you won't be greatly rewarded for your efforts.

The Fund will bear its own expenses, including but not limited to all expenses of operating the Fund; fees and expenses paid to the Administrator and the custodian; fees and expenses for accounting, brokerage, custody, transfer, registration, insurance, interest and other expenses incurred in respect of Fund borrowings and guarantees; finders; its Board of Trustees; legal services, audit services, tax preparation, investment banking, consulting, risk management, research, reporting, investment-related due diligence (including related travel), insurance, indemnification and litigation-related expenses, compliance-related matters and regulatory filings (including, without limitation, regulatory filings of the Investment Manager and its affiliates relating to the Fund and its activities); internal administrative and/or accounting expenses and related costs or charges specifically attributable to the Fund's activities; other expenses incurred in respect of borrowings and guarantees; other expenses associated with the acquisition, holding, monitoring, and disposition of investments; certain technology costs, including hardware and software; consulting fees related to the portfolio management and risk management of the Fund; tax and other operational expenses, such as broker-dealer expenses; extraordinary expenses; expenses of loan servicers and other service providers; and the costs and expenses of any litigation involving the Fund or entities in which it has an investment. The Fund will bear indirectly its pro rata share of the Master Fund's expenses. The Fund also will bear the expenses incurred in connection with the organization of the Fund and in the offering and sale of Shares and, indirectly, the costs associated with the organization of the Master Fund and other expenses of the Master Fund, including the Management Fee. The Investment Manager has contractually agreed to waive its fees and/or reimburse expenses of the Fund to limit the amount of the Fund's Specified Expenses (as defined below and including the Fund's pro rata share of the Master Fund's Specified Expenses), subject to recapture by the Investment Manager if the Specified Expenses of the Fund (including the Fund's pro rata share of the Master Fund's Specified Expenses) subsequently fall below 0.35% (annualized) within the three-year period after the Investment Manager bears the expense; provided, however, that the Investment Manager may recapture a Specified Expense in the same year it is incurred. The Investment Manager is permitted to receive such repayment from the Fund provided that the reimbursement amount does not raise the level of Specified Expenses of the Fund (including the Fund's pro rata share of the Master Fund's Specified Expenses) in the month the repayment is being made to a level that exceeds the expense cap or any other expense limitation agreement then in effect with respect to the Specified Expenses.

“Specified Expenses” is defined to include all expenses incurred in the business of the Fund or Master Fund with the exception of (i) the Management Fee, (ii) the Incentive Fee, (iii) the Distribution and Service Fee, (iv) brokerage costs, (v) dividend/interest payments (including any dividend payments, interest expenses, commitment fees, or other expenses related to any leverage incurred by the Fund or Master Fund), (vi) taxes, and (vii) extraordinary expenses (as determined in the sole discretion of the Investment Manager).

The Master Fund will bear its own fees and expenses, including the Management Fee. It also pays fees and expenses incidental to the purchase, holding and sale of interests in, and bears a pro rata share of the fees and expenses of, any portfolio holding and recurring investment expenses, including custodial costs, brokerage costs and interest charges with respect to investments and any other expenses which the Board of Trustees determines to be directly related to the investment of the Master Fund's assets, including investment-related due diligence expenses (including, but not limited to, travel expenses). These expenses are solely borne, on an indirect pro rata basis with the other feeder funds to the Master Fund (if any), by the Fund, and therefore also by shareholders on a pro rata basis.

The SEC normally requires an investment offering to show, clearly, what those expenses would be on a $1,000 investment, but inexplicably, it gave the Blackstone people a pass, allowing the prospectus, page 20, to show this:

You would pay the following expenses on a $1,000 investment, assuming a 5% annual return

   1-year 3 years 5 years 10 years

$ [        ]  $ [        ]  $ [        ]  $ [        ] 

Of course, there is no market for these shares, nor is any expected to develop. The shares are not assignable or transferable without the prior written consent of the fund. But on page 11, we are told that "the Fund may effect a compulsory repurchase of all or a portion of a shareholder's Shares if the Board deems it advisable to do so." These investments are, effectively, callable bonds.

Will fee-only advisors rush to put their investors in this program, now that the non-traded REIT industry has finally accommodated their service model? Or will my prediction hold up, that these programs are only sold by producers who are well-paid to hold their nose and tout the benefits of illiquidity and opaque fee structures?

Time is about to tell.