- Blackstone’s flagship real estate fund, known as BREIT, has been under pressure for months.
- The firm has recently touted its data center investments amid the artificial intelligence boom.
- Blackstone’s push into data centers comes with its own set of challenges and questions.
To help it reach $1 trillion in assets, Blackstone has wagered big sums on apartment buildings, warehouses, student housing, and other commercial real estate assets that proved to be shrewd investments.
Now, as borrowing costs rise, property values sink, and a once-soaring real estate market has become perilous, the investment giant is turning to ChatGPT for answers — literally.
Blackstone has been talking up data centers with expectations that the industry will benefit from a boom in artificial intelligence and a key new area focus in its $585 billion real estate portfolio. Two years ago Blackstone funds, including its largest single real estate fund, Blackstone Real Estate Income Trust, known as BREIT, took the data center landlord and developer QTS Realty Trust private in a $10 billion deal that has made QTS the centerpiece of its data center ambitions.
Blackstone executives have said QTS’s value has since tripled and that they plan to radically scale it beyond that with $8.5 billion of new data center projects due in the next three years and a $50 billion pipeline of longer-term development.
Data centers house the computer equipment, transmission cabling, and cooling systems that provide the infrastructure behind everyday functions like e-commerce, mobile apps, video streaming, and digital records storage. Artificial intelligence is anticipated to be a major demand driver for the industry in the coming years.
The facilities also consume quantities of electricity so vast they have outstripped the ability of utilities to keep up in some parts of the country. The shortage of power, along with growing public scrutiny, poses risks that could complicate Blackstone’s path to profits.
“Blackstone is highlighting what they think is the best piece of the market right now,” said Glenn Schorr, an analyst with Evercore ISI who covers the company. “We have to see how big this can get.”
Schorr noted that Blackstone has a long track record of executing on new and difficult-to-navigate investment areas.
The trouble with real estate
The push into data centers reflects how Blackstone, one of the world’s largest landlords, has sought to adapt to a fast-changing market where office values have cratered and even robust segments, such as apartment properties, have begun to show cracks.
The turbulence has been especially visible in Blackstone’s $67 billion BREIT, which has had nine months of investor outflows. So far, it has paid out $9.4 billion to redeeming shareholders.
The exodus of cash has brought the fund’s once torrid acquisition pipeline to a virtual halt and raised questions about the viability of its retail investor focus during periods of market volatility.
Stephen Tuckwood, director of investments at California-based Modern Wealth Management, noted that Blackstone’s focus on residential rental buildings and industrial spaces had been “the sweet spot over the last few years” in commercial real estate. But even with a preponderance of those assets, he wonders how long that performance can last as interest rates weigh on all asset types.
“A lot of real estate management firms, whether they’re public or private, are looking to data centers to try and help turn things around a little bit,” Tuckwood said.
Jonathan Gray, Blackstone’s president and chief operating officer, built his career in the firm’s real estate investment group, beginning in the early 1990s. His meteoric rise since has made real estate a core competency at the multifaceted investment company. But the outflows at BREIT have threatened to blemish the track record of Gray, who has championed the idea that the firm should cater more to everyday investors alongside its existing clientele of institutions and high net worth individuals.
Blackstone has labored to flip the BREIT story and depict the fund as a way for shareholders to gain exposure to data centers, even though those assets currently make up only a small fraction of its portfolio.
“Highlighting data centers is very relevant for our investors as the sector has been BREIT’s largest contributor to performance in 2023 and is one of our top four sectors,” a Blackstone spokeswoman told Insider.
To drive home the message, Blackstone recently shared a slide deck with investors highlighting the firm’s investment in QTS. In August, QTS’s chief executive, Chad Williams, joined top Blackstone executives, including Gray, on a BREIT shareholder webinar.
“BREIT has had these outflow issues, and they’re probably trying to show investors ‘look at all these exciting new things we’re doing,'” said Patrick Davitt, a partner at Autonomous Research who covers Blackstone. “You might not own apartment buildings in 10 years, but the largest data center company in the world.”
Trying to ‘stay ahead of the curve’
Since its launch in 2017, BREIT has gained scale quickly by hitching its growth to eye-grabbing trends in real estate, including the strength of fast-growing Sun Belt residential markets and warehouse real estate driven by a pandemic-era boom in e-commerce and supply chain disruptions.
In 2021, BREIT, Blackstone Infrastructure Partners, and “other long-term perpetual capital vehicles managed by Blackstone” purchased QTS. BREIT holds a 33.5% interest in the acquisition.
BREIT disclosed in a financial filing for the second quarter that its data centers holdings, including QTS, now total $5.35 billion and amounts to about 5% of its $125 billion portfolio. The category generated $79.59 million of rental revenue during the first half of the year, the filing stated, the lowest of any property segment in its portfolio.
Blackstone executives insist they can quickly transform that pint-sized niche into a blockbuster behemoth.
According to a shareholder presentation that Insider viewed, QTS grew its revenue to $1.2 billion in 2022, up from $700 million the year prior, when Blackstone acquired it. QTS signed more leases in 2022 than in the previous 15 years combined, the presentation said.
In a recent video posted by Blackstone, Nadeem Meghji, the company’s head of real estate in the Americas, said that since its acquisition of QTS, it had grown the company’s development pipeline more than eight times to $8.5 billion of planned data center projects. Meghji said in the company’s video that interest from data center users in QTS data centers had doubled “since ChatGPT came out.”
“BREIT is not a static portfolio because the world is not a static place,” Meghji explained. “Our job is to constantly stay ahead of the curve.”
Blackstone and other investors in the AI ‘arms race’
Blackstone is joining a crush of investors piling into data center investment and development.
According to CBRE, 2,256.8 megawatts of new data centers are under construction in major markets across the country, and another 7,242 megawatts of announced projects, both record amounts. A study by McKinsey from earlier this year projects that the US data center market will more than double to 35 gigawatts from 17 gigawatts by 2030.
Artificial intelligence and machine learning are expected to provide a major boost to the sector because they rely on heavy computing power.
“There’s a well-publicized arms race happening in AI, and the major tech companies are expected to invest $1 trillion over the next five years in this area, mostly to data centers,” Gray said on the company’s July earnings call.
The growth has prompted greater public awareness of data centers and blowback that has the potential to sting QTS. The company controls one of the country’s largest data center development sites in Prince William County in northern Virginia, which has drawn the ire of some residents and environmentalists, in part because of its close proximity to a historic Civil War battlefield. A local county official who supported the project recently suffered a primary defeat in her bid for reelection, casting uncertainty over whether it will receive necessary zoning approval.
The collapse of that project, known as Digital Gateway, could deal a blow to QTS’s development pipeline and Blackstone’s efforts to gain the scale it has projected.
‘A cautionary tale’
BREIT has dominated a resurgent private REIT business in recent years, which includes competitors such as Starwood and Brookfield.
The fund gives small investors with at least $2,500 to invest and tap Blackstone’s vaunted management and investment expertise normally reserved for large institutions and high net worth individuals. Those same investors, however, have been alarmed by falling real estate values, prompting a surge in refund requests that began late last year. Blackstone has declined to hand back more than the prearranged limits of 2% of the fund’s value per month and 5% per quarter to avoid having to liquidate assets at discounted prices.
BREIT’s largest share class has generated 12% annualized net returns since its 2017 debut and has consistently outperformed the broader REIT industry from its inception through June, Blackstone said in a note to shareholders in early August that measured BREIT’s performance against MSCI’s US REIT index.
In its August investor letter, the fund said that redemptions for July were $3.7 billion, “which is 30% lower than the peak in January, the lowest month of repurchase requests this year and the third consecutive month of declining repurchase requests.”
The news left some investors relieved.
“We suspect the worst of the withdrawals is behind them,” said Selwyn Gerber, the cofounder and chief strategist of Los Angeles-based wealth management firm RVW Wealth, which first invested in BREIT on behalf of clients about a year and a half ago. Gerber said he had recently discussed data center investments with Blackstone representatives and has confidence in the strategy. He pointed to Blackstone’s profitable sale of an ownership interest in the Bellagio hotel in Las Vegas as a recent demonstration of the firm’s broader real estate acumen.
Others are aware of how important alluring assets such as data centers will be in reviving investor interest after a period of waning enthusiasm.
“It’s a cautionary tale,” said Matt Malone, the head of investment advisory at Opto Investments, who previously helped launch a large non-listed REIT at FS Investments. “We all know Blackstone’s done a great job managing a lot of different vehicles. But just like everybody else, they’re not immune. When people want to redeem, they have to sell.”