RE Secondaries – The Time Is Now
The concept of secondary transactions in capital investments plays a crucial role in the financial landscape. As primary capital investments increase, a secondary market often emerges to facilitate the buying and selling of existing assets, structures, or investment positions.
Real estate is an appealing segment of the secondary market, especially with the increased popularity of GP-led recapitalizations. GP-led recapitalizations have evolved from being primarily seen as a means to address challenging or hard-to-sell assets into a strategic opportunity for general partners to safeguard and optimize their most valuable holdings.
Real estate secondary transactions may include acquiring privately held assets (full or partial) from current institutional or high-net-worth investors, as well as purchasing real estate fund interests. They can also use a wide range of legal forms, such as commingled closed-end funds, separate accounts, joint ventures, real estate investment trusts and open-end funds.
As liquidity has been squeezed from the commercial real estate market, demand in the secondaries markets has increased dramatically. Scott Koeing, head of real estate secondaries at Neuberger Berman, said “the universe of closed-end real estate funds has never been larger.”
Given the reluctance or inability, however, of some funds to sell their assets in direct property markets over the last 12 to 18 months, the firm is seeing an increase in current fund investors and sponsors “turning to the real estate secondary market to obtain liquidity.”
Assets under management in closed-end real estate funds have reached an all-time high. The total amount of money raised five or more years ago, the goal of most real estate secondary transactions, has also hit a record of over $850 billion, noted Koeing.
Meanwhile, Ares Management, a global alternative investment manager, believes the current environment for real estate secondaries creates “an exciting opportunity for growth.”
The firm observed that the decrease in transaction volume in 2023 relative to 2022 was not a shock given the unfavorable market environment. However, this has contributed to a “greater pent-up need from both LPs and GPs to generate liquidity,” it recently wrote in its “Recap of 2023 Real Estate Secondaries Market Volume” report.
Real estate secondary transaction volumes, as measured by Net Asset Value, fell to $9.8 billion in 2023, a 21% drop from the record $12.4 billion in 2022. However, the number of real estate secondary sales in 2023 decreased by only 4%, to 154, Ares noted.
The amount of NAV held across closed-end real estate funds has grown to over $970 billion, with $180 billion of this held in funds that are more than eight years old, observed Ares, citing Burgiss data. Furthermore, non-fund vehicles such as joint ventures and separate accounts hold more than $1 trillion in net asset value.
In early December, Ares raised approximately $3.3 billion for its real estate secondaries fund – Landmark Real Estate Fund IX – positioning the firm as a prominent participant in the real estate secondaries market. The strategy has invested or committed approximately $8.3 billion across more than 200 transactions.
While rising interest rates have led property values and sales activity to decline, resulting in reduced distributions to LPs that they had relied on to support their other investment commitments, “these factors should drive a rich opportunity for secondary investors to provide the capital to solve GPs’ and LPs’ liquidity issues,” StepStone Group, wrote in their Bull Market for Real Estate Secondaries report.
The private markets firm recently announced it raised $900 million for its real estate-focused secondaries vehicle.
While certain sectors of the real estate market may face additional stress, the likely peak in interest rates gives some hope that prices for most forms of real estate are nearing a bottom.
“Real estate secondaries are an “excellent” way to capitalize on current market conditions,” added Neurberg Berman’s Koeing. “The lack of liquidity in real estate markets is forcing more LPs and GPs to consider an exit on the secondary market, a situation we think will continue and even accelerate in 2024 and 2025 as the direct property markets take more time to stabilize and fund managers slowly adjust NAVs to the new rate environment,” he concluded.
