The rise of real estate secondaries was rooted in the crisis and opportunity funds. Today, growth is coming from core funds, writes Paul Robinson
The secondary market in real estate funds has come a long way since the crisis in 2007. Before 2009 the market was opaque, there were few dedicated intermediaries, and liquidity was sporadic and expensive to achieve.
There was a divine belief that the ‘book value’ of equity – or net asset value (NAV) – was a statement of value, worth and price (regardless of the accounting convention) and few trades ever occurred where price deviated more than 1-2% from NAV. Few investors genuinely sought to forecast, often because there was a lack of transparency; few distinguished between the type of return, income or capital; and few fully appreciated the impact of leverage.
The crisis exposed this myth as NAVs tumbled, and in some cases equity was entirely wiped out. Investors demanded more transparency as well as standardisation in accounting convention and reporting, to enable them to make judgements about future returns and
the risk associated with them. This enabled investors to make judgements about value, worth and price.
Regulatory changes in the form of Basel III and Solvency II also helped drive change, as has a greater emphasis on the ability to demonstrate ‘best execution’. These were the catalysts that facilitated a growth in dedicated liquidity providers – the secondary specialist funds and a dedicated brokerage infrastructure to support those that want to acquire and dispose of risk.
It is difficult to say how big the secondary market in real estate funds is today. Not all trades go through the brokerage community and there is no central data bank.
Furthermore, the definition of what constitutes a secondary is not universal. Some definitions include buyouts and recaps alongside more traditional transfers in commingled funds, but others – including CBRE’s – do not. Equally, some record the book value transferred, rather than the transaction amount, and include undrawn commitment.
All we can say with certainty is that across CBRE’s global business, including Property-Match, about $2.4bn (€2.2bn) of secondaries, measured solely by transaction value, were executed in 2016 in the form of 200 transactions. Trades were agreed in funds across the US, EMEA and APAC, involving capital from all three regions. In dollars this represents an increase of about 30% on 2015.
So what is driving the growth in secondaries? A key factor is the increased transaction flow in core and core-plus funds, whether structured as open-ended or closed-ended vehicles.
“We suspect the flow of secondaries in opportunistic funds diminished in 2016. Arguably the sector that drove the growth in real estate secondaries is now the laggard”
Increasingly, investors want the certainty of time and price at which they enter and exit an investment, which only the secondary market can afford. Open-ended funds may offer periodic primary liquidity for those seeking issuance or redemptions, but the price at which capital enters or exits is always at a future unknown NAV, sometimes including an offer price premium or a redemption discount.
More importantly, the timing of liquidity in the primary market is seldom assured. Investors seeking exposure may queue up for several quarters before obtaining their exposure; redemptions can be limited in quantum and the timing of receipts is never assured.
The reality is that time and certainty have a value and as investors seek best execution they are increasingly opting for price rather than time to be the primary variable. This is an entirely logical decision when the reality of primary issuance/redemption means that the investor is entering into a forward contract where both the strike price and the timing of an investment are unknown.
Undoubtedly, the secondary market also gained an impetus from geopolitics in 2016. The UK’s decision to leave the EU cast considerable uncertainty over asset values and the trajectory of growth forecasts. Premiums vanished and discounts – often significant in quantum – emerged, but activity increased because there was genuine two-way interest. It also strengthened the depth in demand for continental European funds, premiums increased and trades increased off the back of it.
It is unlikely that the election of Donald Trump will have the same impact in the US, but there is increased concern that the US property cycle is approaching its peak as the Federal Reserve starts to increase rates. The queues to enter core open-ended funds in the US have largely evaporated and redemptions are on the increase. But only if these funds start to defer redemptions will a real secondary market emerge. US investors remain wedded to NAV and trading substantially away from that price remains a challenge for many on them.
While we cannot prove it, we suspect the flow of secondaries in opportunistic funds diminished in 2016. Arguably the sector that drove the growth in real estate secondaries is now the laggard.
This is not caused by a lack of demand; merely the capital employed in funds dating from the peak of the 2006-08 period has diminished as assets are sold to return capital to investors. The number of comparable funds launched – and quantum of capital raised – after the global financial crisis is much diminished and, accordingly, the volume of secondary trading is much lower.
Paul Robinson is executive director at CBRE Capital Advisors