Real estate ‘secondaries’ – the trading of fund interests – is a sector that has been quietly intensifying, as new research shows. Lynn Strongin Dodds reports on the phenomenon.

The secondary market for closed-ended real estate funds – otherwise known as ‘secondaries’ – is following a similar path to its more established private equity counterpart. The secondary trading of private equity funds can trace its roots back to 1982. These deals did not really take off, however, until after the dotcom crisis, when investors were looking for an early exit from their technology ventures. Real estate secondaries are a newer phenomenon, although the basic tenets are the same: interests in property portfolios and/or single assets from existing investors are sold off typically at a discount to net asset value.

According to a report by Landmark Partners, a private equity and real estate investment company specialising in secondary funds, growth in real estate is set to continue as an “expanding number” of institutional limited partners (LPs) and other market participants look to these transactions as a way to manage portfolios. It showed that in the early years of 2000-02 volumes were below $400m (€219.9m) with a spike occurring in 2006 when levels broke $1bn. The following year saw a dip but the market has not looked back since 2007 after which levels have remained buoyant.

”The successful buyers are not coming to the market for deep discounts but are more focused on buying quality assets”

Peter McGrath, Setter Capital

Landmark Partners’ figures reveal that secondaries deals in private equity real estate soared by 50% to $3.7bn last year with the total number of transactions jumping to 56, up from 48 in 2012 (figure 1). The US accounted for slightly more than half of the activity, followed by Europe at 31%. Asia and Latin America saw a fraction of the transactions at 7% and 3%, respectively. The data does not include the entire volume of LP-to-LP trades and, as a result, might understate the aggregate volume of activity. Many of these trades, though, are not public. In addition, it did not assess transactions involving interests in single-asset joint ventures and other private non-fund vehicles.

The study noted that US and European pension funds were the most active sellers in 2013, prompted by an increasing need to rebalance portfolios and reduce the number of general partners (GP) relationships. Banks and insurance companies were motivated by tighter regulations such as the Basel III and Solvency II.

“The difference with our study from others is that we record only completed and not estimated deals,” says Paul Parker, managing director for European and Asian real estate at Landmark Partners. “From a seller’s perspective, we are witnessing a growing number of institutional investors (such as endowments, pension plans and foundations) utilising the secondaries market to drive efficiencies in their portfolios and optimise the exposure they have to private real estate funds. Typically, this might include consolidating their key GP relation- ships or packaging up and selling legacy fund positions.”

Parker also notes that some investors are buying into an existing portfolio to “help smooth out” the J-curve, characterised by upfront costs and a lack of income over the short term, often experienced by investing in new closed-ended funds. “The J-curve illustrates the tendency of private equity funds to deliver negative returns and cash flows in the early years, and investment gains and positive cash flows later in the investment fund’s life as the portfolio companies mature and are gradually exited.”

A separate study by secondaries broker Setter Capital confirms these trends within a wider context. The figures show that $5.1bn of real estate fund stakes changed hands last year, accounting for around 14.2% of a wider universe of secondaries, including those for private equity funds and hedge funds (figure 2). Setter Capital predicts real estate secondaries could have another bumper year as 30% of the 70 buyers it canvassed plan to broaden their focus beyond private equity to other alternative asset classes such as property. Its methodology was defined by total exposure (NAV and unfunded) purchased by the respondent during the year, with reference to closed deals or deals with binding agreements.

“The real estate secondaries market is definitely maturing as we see more buyers and sellers enter the market,” says Peter McGrath, founder of Setter Capital. “There were many sellers that looked at sales through the down- turn, and pricing has finally risen to a level where they can consider transacting. There were only a few buyers a few years ago but there have been several new entrants and opportunistic buyers coming into the market. The successful buyers are not coming to the market for deep discounts but are more focused on buying quality assets and exposure to top managers. I expect the trend to continue.”

Information on who is buying what is thin on the ground. A number of fund-of-funds vehicles were launched in 2010 and 2011 with the specific strategy of buying secondary fund stakes and it is likely they have been major participants in the increased activity. Secondaries funds were launched by, among others, Landmark Partners, Partners Group, Morgan Stanley Alternative Investment Partners and Madison International, and all four companies are marketing follow-on vehicles.

Aberdeen Asset Management announced the launch of its European Secondaries Real Estate Fund in 2013. Sweden’s SEK240bn (€27.7bn) Första AP-fonden (AP1) national pen- sion buffer fund was the lead investor and the new product has so far received €152m of initial commitments. It plans to build a portfolio of approximately 15 funds with collective exposure over 200 properties in Europe. In February, it announced it acquired a portfolio of seven unnamed funds.

Aberdeen identifies more than 100 funds in the fund’s investment universe, spread across a variety of sector, single-country and regional strategies. “We saw an opportunity in the market to target some quality assets and funds at low discounts,” says JohanTemse, one of the managers of the new fund. “Our IRR [internal rate of return] target is between 10% [and] 15%.”

And, while the US has been the main area of activity, there are several investors in Europe who are liquidating their holdings in order to de-risk or meet specific regulations such as Solvency II for insurance companies. The majority of our geographical focus will be in the Nordics and Germany with little exposure in southern Europe or central Europe because they are too high on the risk scale.”

Top five real estate secondaries funds closed, 2010-13
FundManagerFinal Size ($m)Geographic Focus
Partners Group Real Estate Secondary 2009 Partners Group 1,500 Global
Landmark Real Estate Fund VI Landmark Partners 718 North America, Europe, Asia
Morgan Stanley AIP Phoenix Global Real Estate Secondaries Fund Morgan Stanley Alternative Investment Partners 370 Global
Strategic Partners V RE Strategic Partners Fund Solutions 300 Global
CBRE Asia Alpha Plus Fund II CBRE Global Multi Manager 260 Asia, Australia

Source: Preqin Secondary Market Monitor 


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