Is the real estate funds secondary market a short-term arbitrage or a long-term opportunity? Andrew Robinson considers
With the expansion of the real estate secondaries market after the global financial crisis in 2008, it is time to reassess the drivers of secondary real estate sales, particularly with the backdrop of abundant central-bank liquidity. A related matter to explore is whether the real estate secondaries opportunity is a short-term ‘arbitrage’ trade.
In our view, there has been abundant central-bank liquidity since post-crisis quantitative easing began and while the macro liquidity environment has remained largely the same throughout the past five years. We believe the macro environment is likely to remain substantially similar throughout the coming three to five years, with a slow-paced recovery, set-backs and vulnerability to external shocks.
Unlike the real estate crisis of the early 1990s, there has been no government-backed initiative to de-lever the real estate markets at the asset level in a systemic fashion akin to the Resolution Trust Corporation. Policy makers have preferred a private market-driven solution funded with abundant central-bank liquidity. The bank liquidity and the regulatory environment combined to force insurance companies and banks to sell assets, but provided institutions with the capital headroom to de-lever their portfolios and crystallise losses while improving their balance sheets in an orderly fashion. This process has been managed by the institutions themselves, albeit at the insistence of, and pressure from, the regulators and the equity markets. What has not happened, for the most part, is a ‘fire sale’ of assets.
As a result, the secondaries market, which prior to the financial crisis was in its infancy (at least compared with the private equity markets), has been picking up steam with, approximately, a 20% year-on-year growth rate.
With the exception of some situations directly after the financial crisis, where a short-term arbitrage may have been available, the vast majority of sellers do need liquidity to rebalance their portfolios, but are short of being in a truly distressed situation. The types of sellers we worked with four years ago are the same as the ones we are working with today:
• Large international banking institutions where the investment is no longer part of their strategic plans and need to raise additional tier-one capital;
• Hedge funds that made investments in real estate using share classes that are now in liquidation;
• Endowments needing to raise funding for university funding requirements;
• Insurance companies where the investment attracts a higher capital treatment under Solvency II rules;
• Family offices with insufficient liquidity to fund future capital calls;
• Institutions with a large number of manager relationships needing to trim their portfolios to a more manageable size.
Looking forward, it seems likely that the changing regulatory environment, lack of liquidity, deleveraging cycle, which will continue to be undertaken on an asset-by-asset basis, and ongoing balance-sheet repair process has some years yet to run and will continue to generate a healthy secondary deal flow.
We believe that we are still in the first half of the deleveraging and rebalancing process in the US and UK, and have not yet seen this process commence in the euro-zone. We have also not yet seen the height of the CMBS debt maturities, which will generate further deal flow competing with scarce equity capital.
The combination of these elements and the scarcity of equity capital to take advantage of these situations can create a significant liquidity premium for investors that are willing to invest in more illiquid strategies.
Andrew Robinson is a vice-president at Morgan Stanley Alternative Investment Partners