Why Blackstone is the world's top property investor

Blackstone made a huge bet with the Hilton buyout in 2007.

With $344 billion in managed assets, Blackstone Group is the world's largest alternative asset manager and has raised $200 billion in the last five years using strategies and product areas that did not even exist at its IPO in 2007, at the peak of the credit bubble. While its core is a private equity business not dependent on financial engineering or leverage to create value, Blackstone has also emerged as the world's largest property investor. However, storm clouds in the financial markets mean its shares could fall to 25-26 due to lack of IPO exits and stresses in the high yield/bank loan syndications markets. The multi-strategy hedge fund business has delivered dismal returns. While Jonathan Gray's $100 billion assets under management property business has been a winner, Blackstone faces a potential peak in the commercial real estate plus lower allocations from sovereign wealth funds in the GCC/East Asia.
Blackstone has made huge bets with its LP capital in the global property markets; the Hilton buyout in 2007, financed with $5.5 billion on cash and $20 billion in syndicated bank debt. Unfortunately, the leveraged buyout of Hilton, designed to transform a tired, America-centric brand into a global, asset light, managed/franchised hotel powerhouse, was spectacularly ill timed. As the credit bubble peaked in 2007, so did the property cycle. The value of Hilton fell 70 per cent as corporate/vacation travel budgets were slashed in the global recession and Blackstone was forced to inject more cash and renegotiate bank debt in its embattled Hilton buyout. Yet Blackstone was eventually able to transform Hilton into the world's leading hotel management firm, floated its shares in a New York IPO in December 2013 and eventually earned $10 billion on its equity in the once-underwater deal.
The 2008-09 banking and credit trauma changed the landscape of global property investing. Morgan Stanley and Goldman Sachs' buyout funds were devastated in the crash. Blackstone used the tsunami of home mortgage foreclosures to buy 50,000 homes, spent an average of $25,000 per house on refurbishment and rented them out to millennials disenchanted with the former American dream of home ownership. Blackstone is now the world's largest owner of commercial real estate, as well as the largest US residential landlord.
Even though Blackstone has made massive, concentrated bets on real estate bets, it has also nimbly timed the property cycle and not overpaid for assets, a fatal mistake since property returns are so dependent on bank leverage and capital markets. For instance, Blackstone sold vast parts of the $39 billion Equity Office Properties office tower empire to New York developers, some of whom later went bankrupt because they overpaid for assets they financed with too much bank debt. Blackstone's property funds have returned a stellar 17 per cent composite return making them a magnet for the world's savviest pension funds, sovereign wealth funds, insurance companies and family officers. No other property investor in the world has so successfully timed property cycles driven by cranes, construction, footloose capital and ego!
Yet private equity faces myriad challenges. Dodd-Frank places private equity and hedge funds under the regulatory scrutiny of the SEC. Investors have revolted at the idea of paying exorbitant fees without value creation. European regulators have cracked down on post-acquisition asset stripping and dividend recapitalisations. There are also Basel Three-related constraints on US syndicated bank loans to finance leveraged buyout deals on Wall Street.
Blackstone shares have fallen 34 per cent in the past year to 28. First-quarter revenues 2016 dropped 65 per cent and net income plunged 85 per cent on the prior year. The dismal exit markets for leveraged buyouts, the risk premium spike in energy high-yield debt and commercial mortgage backed securities and awful hedge fund performance have all taken their toll. Even though Blackstone slashed its dividend by 70 per cent, its dividend yield is still thre per cent. The firm is now a $344 billion AUM colossus. My buy/sell range on Blackstone remains 26 to 35 in 2016.