It's easy to pinpoint the first shot of market contagion... with the benefit of hindsight.

Think about the mid-2000s, when Bear Stearns' mortgage funds had to be bailed out by its parent bank. That was a clear warning sign.

Bear Stearns was one of the best Wall Street investment banks at the time. Then, two of the bank's internal hedge funds went belly up during the summer of 2007.

Prosecutors launched a criminal investigation that October. And by the time JPMorgan Chase (JPM) stepped in and bought Bear Stearns in March 2008, the stock had plunged from $130 per share to $2 per share.

Looking back, folks say Bear Stearns was the obvious beginning of something bigger. Yet it wasn't so clear the day it happened.

Now, we're likely on the brink of another recession. We still don't think it will be anything like we saw in 2008. As we've explained previously, corporate balance sheets are still healthy. That should prevent a wave of defaults like we saw in 2009.

That said, if we had to wager on the origin of the next downturn, we'd expect it to come from the real estate market.

This shouldn't be a shock for regular readers. We believe the biggest looming issue is figuring out commercial real estate (and offices in particular).

Real estate just showed its first sign of wear... in a surprising place. Rather than offices, this warning sign comes from a big holder of multifamily homes and warehouses.

The Blackstone Real Estate Income Trust ("BREIT") is owned by investment-management company Blackstone (BX). It's a fund that lets high-net-worth investors buy into commercial real estate properties.

BREIT's latest move has shaken investors. It recently announced that it's limiting withdrawals... right as more investors are trying to sell out. BREIT keeps most of its money in real estate, which means it's unable to handle a massive surge in redemptions.

The new rule means investors are limited to withdrawing 5% of their holdings per quarter. It would take at least five years for anyone to completely sell out.

It was a huge ding to Blackstone's reputation. Its stock fell roughly 4% the day BREIT announced its withdrawal plan.

This could be the first sign of what's to come for the market...

Yet it's still nothing like 2008.

Bear Stearns was mixed up with the rest of Wall Street in a concerning – and public – way. All the big banks had been placing risky bets in areas like real estate. Bear was the first domino to fall.

On the other hand, Blackstone is a private-equity firm. Its investments shouldn't be of much concern to the public. Most people don't have access to BREIT. Fewer still probably knew it existed before last week.

Plus, we need to consider why folks wanted to sell BREIT so badly.

It's probably not because BREIT is in serious trouble. Like we said, it's actually in a strong part of the real estate market.

Multifamily homes and warehouses have much higher demand than office spaces these days. That doesn't appear to be changing anytime soon.

Rather, higher interest rates hurt the real estate market. That means investors could be looking to rotate out of real estate as a whole.

Folks also tend to do exactly what they shouldn't... sell their winners.

It's psychologically hard to sell losers. We like to think of ourselves as good investors. So when an investment goes sour, we tell ourselves it's because the market just doesn't get it yet.

When investors are looking to raise cash, they don't want to sell the investments that are down a lot. They feel like they're throwing out an opportunity to profit when it turns back around. They'd rather sell what's already up.

Warehousing and residential real estate were two of the best performers in 2021. They returned about 63% and 58%, respectively.

After such a great year, some of these withdrawals could simply be from investors selling their winners.

BREIT could be the first signal of something worse – or not...

Regardless, it serves as an important reminder.

Interest rates are rising more than they have since the Great Recession. The real estate market is challenging. It's important to pick your sectors intelligently.

More than 50% of an investment's return can be predicted by its sector alone. Getting that wrong can set you up to fail... even if the fundamentals are sound.

Some parts of real estate, like warehousing, have the potential for growth in the near term. That being said, the sector as a whole reported disappointing earnings in the third quarter.

Steer clear of real estate for the time being. Until things turn around, it's not a priority sector heading into the new year.


Joel Litman
December 14, 2022

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