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PERE SECONDARIES REPORT 2015 A special supplement to PERE magazine

EDITOR’S LETTER

Secondaries school is in session If ever there is a subset of the private real estate investment world that is concurrently exciting, intriguing, yet confusing and frustrating at the same time, it is private real estate secondaries. It is a marketplace that has seen transaction volumes exponentially rise over two decades as growing numbers of buyers understand its virtues as a conduit to the property asset class and sellers recognize its virtues as an option for liquidity. And yet secondaries remains a marketplace hard to define. What is the true characterization of a secondaries transaction? How much actually is for sale? How do you effectively measure pricing? Does a trade invariably suggest the seller has made miscalculations when underwriting its primary commitment? These questions still elicit a spectrum of responses. That last question less so. As the market evolved, the notion that being a seller of secondaries is tantamount to an admission of previously getting things wrong is, at last, going away. Large sales this year by venerable institutions like CalPERS, GIC and Harvard have done much to assuage prior suspicions. Symbiotically, as the number of sellers exiting via the secondaries market has grown, the amount of capital raised by the folk who would buy them has grown too. Indeed, in Partners Group, Landmark Partners, Strategic Partners, Madison International, Portfolio Advisors and a handful of other investment managers, the sector already has its champions. Their secondaries funds are growing in tandem with the opportunity at hand. Yet, speak to executives at these firms and they’ll tell you there’s still plenty of work ahead in terms of educating would-be traders. Today, 0.6 percent of the primary private real estate market trades annually on the secondaries market compared to 1.5 percent in the better established private equity equivalent, Landmark says. Every voice featured in this magazine expects that bigger picture to improve with better education. That is the purpose for this, our inaugural special magazine on the topic. Over 28 pages you’ll glean a greater understanding of what some of the smartest minds in the space have to say about the market as it stands today and as it will look tomorrow. We think it makes for essential reading and hope you do too. Regards,

Jonathan Brasse Senior Editor [email protected]

THE SECONDARIES REPORT 2015 | PERE

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TABLE OF CONTENTS 4 Top stories

PERE reviews the 10 best read stories related to real estate secondaries in the last year

8 Motivational shift

Institutional investors are selling LP stakes more for strategic than distress reasons, points out Strategic Partners’ Mark Burton. By Florence Chong

10 Chasing complexity

A stabilizing real estate secondaries market is forcing the sector’s biggest players down the ‘non-traditional’ route of restructuring or recapitalizing funds to find greater returns. By Meghan Morris

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14 Not all about discounts

A secondary purchase at a premium to NAV can still be a good deal if there is growth to capture, argue Mark Wilkins and Johan Temse of Aberdeen Asset Management. By Florence Chong

16 Hopes and concerns of a staple diet

Stapled transactions are a growing phenomenon in the private equity secondaries market, writes Secondaries Investor editor Marine Cole, but not everybody is excited about them

18 Valuation the topic, always

Real estate secondaries valuation is in its infancy, but more specialized advisors will lead to greater reliability, writes Morag Beers, former investor relations executive at Composition Capital

20 No third wheel

Successful secondaries transactions depend not only on alignment between buying and selling LPs but with GPs too, say Greenhill Cogent.

22 Greater awareness

Secondaries investing has some way to go before it is fully understood by the private real estate universe. Secondaries Investor editor Marine Cole hears how, bit by bit, education about the subasset class is spreading

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28 David versus Goliath

2

PERE and PEI Research & Analytics compares the fledgling real estate secondaries market with the more established private equity equivalent

PERE | THE SECONDARIES REPORT 2015

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TOP STORIES | SECONDARIES

Banner year for secondaries Nearly all of this year’s top secondaries stories had superlative headlines reflecting a market that continues to grow

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DEALS

CalPERS’ $3bn sale to Blackstone

The biggest US public pension fund inked a deal in exposure to emerging market funds. The pension plan’s legacy November with Strategic Partners Fund Solutions, a portfolio had exposure to more than 70 fund interests as of subsidiary of The Blackstone Group, to sell $3 billion in real June 30, according to documents from the pension fund. estate holdings in what was the largest secondary transaction CalPERS began reworking its real estate portfolio after it to date. suffered a 37 percent loss in 2010. The global financial crisis The California Public Employees’ Retirement System erased about $10 billion from CalPERS’ real estate portfolio, (CalPERS) has been on a year-long quest to rework its real or about half its value, overall. The pension giant shifted into estate portfolio after losses incurred from less-speculative assets in 2007 after previously investments in the asset class made during the targeting higher-risk investments, focusing global financial crisis. now on core investments such as multifamily, CalPERS has been unwinding its relationindustrial parks, offices and retail space. The ships with fund managers across sectors as it pension plan now has about $27.1 billion of its attempts to streamline its portfolio and reduce $284 billion invested in real estate, below its fees. In June, the pension giant said it planned target of $28.4 billion. Number one: the November transaction was biggest-ever to cut about half of its outside money managMore than 10 co-investors, including public secondaries sale ers – it currently works with about 200 – by pension funds and sovereign wealth funds, 2020. The portfolio, which entails about 10 joined with Strategic Partners in the purchase. percent of CalPERS’ real estate assets, is made up of 43 interBlackstone acquired Strategic Partners from Credit Suisse national and domestic funds from its non-strategic, legacy real Group AG in 2013. The fund investor had $17.3 billion in estate portfolio. committed capital as of September 30, according to the firm’s The funds are predominantly based in the US, with a third quarter earnings statement, with $4.2 billion available significant exposure to European funds as well, and a small to invest.

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RESEARCH

Partners: Non-traditional RE secondary deals on the rise

Partners Group has been investing in real estate involving the extension of hold periods in order to maximize secondaries transactions for years, but this year the value of the remaining properties in those portfolios. extolled the virtues of pursuing a particular and non-tradi“Term extensions are now often the rule rather than the tional path in the investment space. exception and some investors are likely to become fatigued The Zug, Switzerland-based investment and motivated to sell out of these promanager noted that a significant uptick grams,” the investment manager said in its in demand for real estate secondary deals report. “These investors will increasingly had increased deal flow, but also had driven offer new opportunities for secondary up pricing expectations and created a ‘spin-out’ scenarios or a formal tender greater mismatch between real estate secoffer.” ondary pricing and underlying property In March, Partners closed on one such Nordic: more non-traditional deals like this to come fundamentals. deal, involving a 2005 vintage real estate In an August report, Partners said a wave portfolio comprising 28 retail, mixedof 2005 to 2008 vintage funds and other investment programs use, office, industrial, hotel and parking properties located will start to mature beginning this year. These maturities are throughout Norway. In transacting on the portfolio, which expected to generate new opportunities outside of traditional has a 5 percent vacancy rate and annual net operating income portfolio sales on the real estate secondary market, primarily of €34 million, the firm made a tender offer to provide 4

PERE | THE SECONDARIES REPORT 2015

liquidity to existing investors in the portfolio. The investment manager noted in its report that because of heightened competition for traditional real estate secondary deals, large offerings were attracting buyers with return targets of less than 10 percent. Partners raised the largest-ever real estate secondaries fund, Partners Group Real Estate Secondary 2013, closing the vehicle at its hard cap of $1.95 billion in October 2014.

3

Best of the rest on

PERENews.com [Secondaries]

in last 12 months

4

DEALS

GIC’S $1BN RE SECONDARIES EXIT In August, the Government of Singapore Investment Corporation (GIC) hired Greenhill Cogent to sell a large portfolio of real estate fund interests in a $1 billion transaction expected to close at the beginning of 2016.

Northwood recapitalizes French fund

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Northwood Investors recapitalized STAM Europe’s 2007-vintage fund, STAM REI III, with the acquisition of a 15-property portfolio for €164 million in October. The New York-based private equity real estate firm is understood to have purchased the assets at a premium to their net asset value. Known collectively as the Printemps Portfolio, the 15 assets encompassed more than 936,460 square feet of office and industrial space in the Paris region and a number of regional markets in France. The properties included Clichy Urbia, a Class A office building in the Paris region; the Toscane Portfolio, a portfolio of nine office properties also located in the Paris region; and the Prosdim portfolio, which comprised five industrial properties in regional French markets. STAM Europe will continue to manage the assets in the Printemps Portfolio. STAM REI III, which raised a total of €365 million, was said to be nearing the end of its life. An auction process was held to bring in a new investor to recapitalize the fund. Northwood is said to Clichy Urbia: part of €164 have bought out all of the limited million recap partners’ interests in the Printemps Portfolio, providing liquidity to the investors in the process. However, all of the LPs remain in STAM REI III, and Northwood has not acquired an ownership stake in the fund. Following the Northwood acquisition, PERE understands that only a few investments remain in the fund, which is expected to be fully liquidated in the coming months. Accord Europe, a San Francisco-based advisory and capital raising firm, represented STAM Europe on the deal, while Northwood was self-advised. Northwood, which manages approximately $5.6 billion of assets, has offices in New York, Denver, Los Angeles, London, Luxembourg and four regional UK cities. STAM Europe, which was founded in 1997, has closed on €3.3 billion of investments and currently has approximately €500 million of assets under management through value-added funds and separate accounts.

HARVARD SELLS HALF OF OFFERING As of August, Harvard Management Company (HMC) sold about half of the $1 billion real estate secondaries it put on the market earlier this year.

6

PARTNERS BUYS NORDIC PORTFOLIO An offshoot of Brunswick Real Estate sold a portfolio to Partners Group in a transaction that closed August 31. The portfolio has a value of about SEK 3.2 billion (€335 million; $378 million) and includes 32 properties across asset classes in Sweden, Finland and Estonia.

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CBRE GIP BRINGS FUND TO $1.2BN CBRE Global Investment Partners, the indirect real estate arm of Los Angeles-based CBRE Global Investors, exceeded $1.2 billion of total equity commitments in January for its flagship global open-end property fund, Global Alpha. The firm added $528 million in 2014.

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LANDMARK IN $1.6BN HOARD Landmark Partners closed its latest real estate secondaries fund at $1.6 billion in May. The firm planned to use capital from the fund to continue its secondaries strategy of acquiring interests in existing funds and partnerships invested in underlying real estate globally.

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PORTFOLIO ADVISORS CLOSES FUND Portfolio Advisors closed Portfolio Advisors Real Estate Fund (PAREF) V at the end of October. The $437 million vehicle is the largest-ever real estate fund of funds for Portfolio Advisors.

10

LANDMARK BUYS EUROPA FUND STAKES Landmark Partners acquired limited partnership interests in two of Europa Capital’s funds in April. Landmark bought the stakes in both funds from Southern Methodist University’s $1 billion endowment.

THE SECONDARIES REPORT 2015 | PERE

5

NEWS IN NUMBERS

30 percent

6th

Increase in global real estate secondaries market transactions, excluding LP-to-LP transactions, in 2014 over the previous year, according to data by Landmark Partners

Real estate secondaries fund launched by Madison International Realty with a $950 million capital raising target in March

$1.6 billion

$1 billion

Raised in the final close of Landmark Real Estate Fund VII, exceeding the initial fundraising target of $1 billion in May

32

Number of properties in the SEK3.2 billion (€335 million; $378 million) portfolio purchased by Partners Group from Sveafastigheter, part of Brunswick Real Estate, in September

2

Estimated size of the real estate secondaries portfolio being prepared to be put up for sale by GIC Private in August

Estimated size of the real estate fund interests sold by Harvard Management Company in August out of the total $1 billion portfolio up for sale

10

Europa Capital funds received investment from Landmark Partners in April. The firm acquired the LP interests via its Landmark Real Estate Partners VII

Swiss properties owned by Helvetica Swiss Real Estate Danmark that were acquired by Partners Group in December

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PERE | THE SECONDARIES REPORT 2015

$500 million

Raised by Morgan Stanley Alternative Investment Partners for AIP Phoenix Global Real Estate Secondaries Fund II in February

KEYNOTE INTERVIEW | STRATEGIC PARTNERS

Motivational shift Institutional investors are selling LP stakes more for strategic than distress reasons, points out Strategic Partners’ Mark Burton. By Florence Chong

Strategy: secondaries sales are part of portfolio management

A

s an investor in some 275 private real estate funds, it real estate immediately before the global financial crisis. is hardly surprising that Blackstone’s dedicated fund Says Burton: “In our view, institutional real estate invessolutions platform, Strategic Partners, has an undertors today are highly focused on addressing their exposure to standing of why increasing numbers of institutions are selling commingled funds of the 2005 to 2007 vintages. In an effort their limited partnership positions. to optimize their illiquid portfolios and reallocate capital to Whether for a multi-million-dollar portfolio of dozens of fresh initiatives, we see real estate portfolio managers who are funds or a single holding valued at less than $1 million, the increasingly embracing the secondary market as a key portfoglobal firm is usually one of the first calls for sellers. So far lio management tool.” this year, Strategic Partners’ real estate secondary transactions Burton says that at this stage of the real estate cycle original have aggregated to a net asset value of more than $3 billion. investors appear increasingly motivated to simplify their portMark Burton, head of Strategic Partners’ folios and move forward with a smaller set real estate business, tells PERE: “In today’s of managers with strategies that align with “The seller motivation market we work with sellers of all shapes remains consistent: active their current strategic objectives. and sizes. Because our franchise has always “The seller motivation remains conportfolio management of been agnostic to transaction size, one day sistent: active portfolio management of a a real estate allocation we’ll be working with a US state pension real estate allocation through disposing of through disposing of on a $500 million portfolio and the next legacy fund exposures.” legacy fund exposures.” day we’ll be working with a family office The upshot is a growing marketplace for on a $500,000 transaction.” buyers. Strategic Partners has tracked real In between, there is a wide variety of sellers, ranging from estate secondary volume growing from less than $500 million sovereign wealth funds, banks, insurance companies, endowin 2005 to more than $6 billion last year. The firm sees more ment plans and family offices to corporations selling down than $10 billion trading in 2015 as portfolios being offered get their balance sheet holdings. bigger and bigger. “For secondary buyers, this should represent an opportuCommon vintage nity to purchase stable, cash-generating real estate assets in But while seller type can vary, Burton says there is currently a gateway markets at reasonable pricing,” says Burton. common theme amongst the vintages of fund most sellers are Myth-busting bringing to the market. Invariably, the firm sees for sale units Burton believes a major myth relating to seller motivations from 2005 to 2007 vintage funds – those vehicles used to buy 8

PERE | THE SECONDARIES REPORT 2015

needs busting: that distress is the cause. He says: “It is a com100 different investments, reducing the number to 25 would mon misunderstanding that seller volume is being driven by ensure the oversight of its holdings is more efficient. distress. Conversely, volume is being driven by portfolio manJoining the US pensions are sovereign wealth funds which agement strategies.” also are now starting to reduce the number of funds from For him, these strategies typically involve three sub-stratesometimes 50 or more to as few as 10, in Burton’s experience. gies. Firstly, and as already touched on, there are sellers looking That means plenty of disposals on the secondaries market. to simplify their portfolios with fewer GP relationships. A The motivation of sovereign sellers, he says, is similar to that reduction in fees paid to managers is a side benefit of that. of state pension plans. They, too, are looking to simplify their Secondly, there are sellers looking to deploy more capital in investment portfolios. direct strategies, where they ultimately have more control over Going direct major decisions. Such control is not something they can enjoy Another powerful rationale to sell fund positions in traditional commingled funds. on the secondaries market is to shift from indirect And thirdly, some sellers, mainly financial to direct real estate holdings. Burton sees global institutions, are selling due to regulatory pressures investors including sovereign wealth funds and and balance sheet treatment. Burton says US and pension funds that had been regular fund invesEuropean banks were the major sellers three years tors preferring direct outlays these days. Again, to four years ago. Financial institutions which control over assets is a central tenet of their previously took large positions in private equity thinking. real estate funds had to sell them for regulatory “In their view, it is much better to control their reasons. The Dodd Frank Act or Basel III are two own destiny. They want to make the decision on such regulatory catalysts. Burton: distressed when to buy or sell. If they want to hold an asset As such, he says: “banks have provided a big secondaries sellers is a misconception for 25 years, they will. They couldn’t do that if they source of deal flow for us and we are continuing to were in a fund structure where they are completely buy from them.” passive investors.” Benefits of streamlining There are tax implications too when switching codes from But the most active sellers this year have been US state pension indirect to direct. Large institutions look to tax-efficient strucplans. Three plans, including the California Public Employees tures on a deal-by-deal basis and, as they acquire assets, they Retirement System (CalPERS), have sold large portfolios of adopt structures bespoke to the individual investment, somesecondaries. CalPERS sold its portfolio to Strategic Partners thing not possible with investments made to funds. (see box). Summarizes Burton: “These sales are not characterized by The firm cannot discuss that transaction. But Burton says, distress in any way”. generally speaking, US state pension funds are examples of As private real estate continues its education in this bursellers that want to simplify their portfolios and to reduce geoning corner of the marketplace, this is one lesson likely to fees paid to external managers. If these pension plans have become understood sooner rather than later.

The big one Last month, Strategic Partners made the biggest secondaries trade to date. In the biggest single secondaries sale yet, Strategic Partners Fund Solutions last month bought $3 billion (£1.96bn, €2.8bn) of real estate fund interests from the California Public Employees Retirement System (CalPERS). The portfolio is made up of secondaries in 43 international and domestic funds from CalPERS’ non-strategic real estate portfolio, and represents approximately 10 percent of CalPERS’ $25 billion-plus real estate investment portfolio.

CalPERS has been unwinding many relationships with real estate, private equity and other external fund managers as part of a broader effort to simplify its portfolio and to reduce fees. In June, the pension fund said it planned to sever ties with roughly half of its outside managers by 2020. The real estate sell-off was among the first initiatives coming out of that strategy.

THE SECONDARIES REPORT 2015 | PERE

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SPECIAL REPORT | NON-TRADITIONAL SECONDARIES

Chasing complexity A stabilizing real estate secondaries market is forcing the sector’s biggest players down the ‘non-traditional’ route of restructuring or recapitalizing funds to find greater returns. By Meghan Morris

Xintiandi development: Partners’ ultimate asset after Venator secondaries deal

T

hose with longtime involvement in the relatively niche world of real estate secondaries point to an overall strong marketplace as a signal for the continued growth of its smaller, non-traditional secondaries subset. According to advisory firm Evercore, the traditional real estate secondaries market saw transaction volume jump from $390 million in 2005 to $5.2 billion in 2014 – a number Evercore predicts will stabilize between $6 billion and $8 billion in the coming years. Within this growing volume is the number of transactions involving firms taking the nontraditional route of restructuring or recapitalizing private real estate funds, particularly those from the 2004-2008 vintage years, as a way of capturing value in such a heated marketplace. Within the non-traditional secondaries space buyers have room to experiment with different approaches, although three have come to the fore of late. Restructuring, where the buyer purchases all of the investors’ interests in the fund; recapitalization, where the buyer purchases all of the interests in a particular portfolio within the fund; and a hybrid traditional/ non-traditional deal where the buyer purchases the limited partners’ interests in addition to a further stake in the fund. Yet, these portfolio or entity-level investments require a higher degree of underwriting specialization, as non-traditional secondaries buyers must drill down into asset-specific data, such as occupancy rates.

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PERE | THE SECONDARIES REPORT 2015

This specialization can be a benefit, as better information – and control – is available at the asset level as opposed to a traditional limited partner stake. However, investors also assume a higher degree of concentrated risk with fewer assets than a larger commingled fund. Non-traditional secondaries players say the risk of this type of play lies in the origination and execution of the deals. But they require deep knowledge of local markets and sophisticated investment capabilities. “In many ways, a secondary position is a much safer investment than a blind pool investment,” says Nishant Bakaya, a managing director in Evercore’s Private Capital Advisory Group, the arm of the investment bank’s business that specializes in secondary transactions for private fund interests. “It should be, if you’re good at what you’re doing,” adds Bakaya’s fellow managing director, Jarrett Vitulli.

Market evolution The real estate secondaries market really got going in 2010, says Marc Weiss, head of the private real estate secondaries and primaries at Zug, Switzerland-based investment manager Partners Group, as endowments and foundations precipitated a wave of selling on the heels of the financial crisis, looking for more cash in an illiquid market. It had stayed small during the downturn because assets commanded much lower prices. “We should have bought everything in sight, but we did a

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SPECIAL REPORT | NON-TRADITIONAL SECONDARIES

lot of deals,” says Weiss. the US alone that are candidates for restructuring. If even 25 The market continued to grow when, from 2011 to early percent of these are part of a restructuring process over the 2013, the selling shifted from endowments and foundations to next three years to five years, it could potentially propel secbanks and insurance companies which needed to shed assets ondary activity in real estate funds to more than $10 billion for both financial and regulatory reasons. annually. Today, large institutional investors are seeking to sell funds Data from advisory firm Setter Capital indicates a rise in and assets from 2004 to 2006 that have performed poorly, transactions driven by real estate fund managers as they seek because these funds’ capital was invested at the peak of the partial realizations and extend assets’ time in the market for market. Investors, including pension plans and sovereign better returns. Small non-traditional transactions can also be wealth funds, want to sell these vintage funds to then redea way for new potential investors, such as family offices, to ploy the capital. As the number of sellers has grown with real establish a relationship with a fund manager before making estate’s overall recovery, the pool of institutional buyers has a bigger investment. also gotten deeper. As more investors enter the market and the vintage funds “If you’re a sponsor right now of a fund, this is the perfect from the global financial crisis close, there is less runway for market to be selling assets into. You should be a net seller,” traditional secondaries growth after lower levels of fundraissays Weiss. ing in 2008 to 2010, says Partners Group’s Weiss. But he adds that the sector’s biggest players are likely to Investors are also not keen to sell stakes in the 2008 to 2010 place more emphasis on non-traditional transactions as vintage funds raised by The Blackstone Group, Starwood “there’s a much higher degree of sensitivity in Europe and Capital Group, Brookfield Asset Management and other Asia for people to sell something for less than they say it’s sector giant firms because there is little distress in these bilworth. That is going to be a retard on restraining further lion-dollar funds. That upcoming lack of opportunity in the growth for traditional secondaries.” traditional secondaries space helped push Yet the non-traditional route looks set secondaries players such as Partners into “I think we can do to grow as real estate fund managers are better for our investors non-traditional deals. adjusting to the idea of restructuring or “There’s only so long you can continue to doing off-market, recapitalizing. “The limited partner market thrive buying vintage funds,” Weiss says. non-traditional deals.” may begin to stabilize,” Evercore’s Vitulli “For the people who aren’t in the space says. “We’re in the early stages of seeing an already, it’s probably too late. For those who increase in general partner-led transactions where real estate have entered the space in the last year, I think it’s going to be GPs will either try to spin out assets, restructure existing tough for them to carry on in a measurable way.” funds or roll assets into a vehicle structure.” Mike Bego, a former partner at New York-based secondarPartners was one of the first groups to complete such a ies investment manager Willowridge Partners, thinks there is secondaries deal. Back in August 2014 the firm acquired the still room left in the market, particularly for small deals that equity positions of 31 investors in one of Asia’s most controescape major players’ attention. versial funds – the Trophy Property Development fund, a After a decade working in secondaries, he left Willowridge China-focused development fund which attracted $1 billion to set up his own shop, Kline Hill Partners, in October. Bego of equity from 145 investors prior to the global financial criis looking for leftover pieces – investments with a “lower sis. The fund, now managed by Apollo Global Management, single-digit millions” price tag, in contrast to the $10 millionwas marred by disputes between the manager, its developand-up deals in which most firms typically invest. ment partner and its investors. Its investments then failed “People tend to get less interested as things get smaller,” he to perform as expected and the fund’s valuation was written says. “It’s an attractive part of the market because we can solve down by more than half. problems for people.” Partners provided 31 of the vehicle’s 145 investors an exit, But, with Evercore in September estimating that the level making the firm the second-largest investor by commitment of available dry powder in the hands of real estate secondaries in the funds. The Trophy Fund was originally organized as a buyers is about $7.3 billion, the need to put money to work seven-year vehicle, and over the course of restructuring, the will force more down the non-traditional route. program’s advisory board extended its life by two years to As Weiss says: “I think [traditional secondaries] is a good April 2017. place to put money, and I think it’s a service to the overall Evercore’s Bakaya says that there is approximately $30 bilmarketplace. But I think we can do better for our investors lion of net asset value within bubble-era real estate funds in doing off-market, non-traditional deals.” 12

PERE | THE SECONDARIES REPORT 2015

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KEYNOTE INTERVIEW | ABERDEEN ASSET MANAGEMENT

Not all about discounts A secondary purchase at a premium to NAV can still be a good deal if there is growth to capture, argue Mark Wilkins and Johan Temse of Aberdeen Asset Management. By Florence Chong

Discounts gone: growth is now an important driver for deals

F

ive years ago, Aberdeen Asset Management’s real estate secondaries team bought into a London officefocused fund at a slight premium to net asset value. It was a surprising deal because, post-global financial crisis, real estate secondaries – which often had been sold from troubled funds - were coming to the market at steep discounts, sometimes as much as 50 percent. But the Aberdeen team had good reason to execute the transaction. They believed in the London office market, that a recovery was imminent. The market had peaked in between 2007 and 2008, just before the global financial crisis that swept across major real estate markets around the world. Says Johan Temse, an investment manager with Aberdeen for the past nine years: “We thought we were buying into the fund at the bottom of the cycle because we believed there would be rental growth and cap rate compression coming back into the market. And the manager had a good track record of letting space.” The fund units were purchased at a small premium to latest reported NAV. And sure enough, capitalization rate compression began in the subsequent quarters. “There was strong growth both from the underlying market and the portfolio,” says Temse. “We had captured a lot of that market improvement by the time we exited the investment three years later.” “That shows you don’t need to buy at a great discount to

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PERE | THE SECONDARIES REPORT 2015

get a good investment. It is more about understanding what you are buying into, understanding the market and the pricing,” Temse says. Generally, investors in today’s secondaries market have a more positive view of the underlying real estate market, he says. In fact, Temse expects more capital appreciation for assets in the next 12 months. Today many secondaries are bought at valuations which lag the primary market, and, when the assets come to open market, transacted prices are often higher than reported NAV, he says. “Even when we were making trades on large discounts a few years ago, we were still looking through individual real estate funds to assess the quality of the manager and the quality of properties in the funds,” says Mark Wilkins, head of Aberdeen’s European property multi-manager team. Attractive discounts can help sweeten a deal. But no decision should be made based purely on discounts alone, he says. The large 20 percent, 30 percent or 40 percent discounts available earlier this decade carried with them inherent risks, such as expected future property value write-downs or write-offs or large re-financing risks. Temse quotes an example of Aberdeen two years ago buying a big portfolio at a big discount. “Of the seven funds acquired, we saw further write-downs in one of them and the turnaround came later there than in the other funds,

which we could price in”

Time to capitalize

investment team to conduct the due diligence required by our clients.” Temse says intimate knowledge of a local market, detailed knowledge of actual assets and existing relationship with managers as well as a good picture of the global market adds to confidence to invest in particular funds. When the team was buying into the London office fund in 2010, it had a good grip of the local market and outlook for potential growth. When it was able to overlay that knowledge with its experience of the skills of the asset manager and the fund manager that made it easier to stack up an investment. He says that while an incoming investor is able to access information on income, and to look at rental contracts, it is the skills of the manager that can make the difference to final returns. The manager can add value to a building. He works out a strategy to fill empty spaces, undertaking refurbishment, extensions or minor development to enhance a building and increase rental income.

The manager is now selling assets from the funds at prices above valuation, capitalizing on the current strong investment market. “We have already received some gains on that portfolio,” Temse muses. Wilkins says: “What we are seeing now is that the discounts aren’t as large, so buyers and sellers have to be much more comfortable with what they think is going to happen to the real estate.” That means having in-depth knowledge of the fundamentals of individual local markets in terms of supply and demand equilibrium, the strength of space absorption, the outlook for rental growth, and so on. Wilkins says: “We have a large global investment team who are invested in over 100 unlisted real estate funds. We also have a dedicated property research and strategy team. So we know where the growth stories are.” Secondaries from secondary He reiterates the need to spend time with Wilkins says it is very important, too, to differmanagers and asset managers, looking at indientiate secondaries from secondary assets. vidual assets. “We have a number of European mandates “Clearly, we need to look at the price we are looking for secondaries in core funds,” he says, paying in a transaction. Many people look at adding that secondaries in these funds do not the discount or premium numbers, but we think come with big discounts. But investors with that that is only half of the story. We go through core strategies are prepared for lower returns in each fund in detail, property by property, and Wilkins: underlines the range of 6 percent to 8 percent.” we discuss with the manager the business plan importance of good person Over the past five years, Aberdeen has comfor each property.” to deal ratios pleted approximately 180 transactions in real The Aberdeen team works out a financial estate secondaries on both the sell and buy model for its investments, including forecast sides, with a collective value of €900 million. returns and an exit price for each of its investments. In July last year, it held the final closing for its first second“You need to understand what you are buying into,” says aries fund, which invested the proceeds in core markets such Wilkins. “A secondary purchase at NAV or even at a preas the UK, Germany, France, and the Nordic countries. mium to NAV can still be a very good deal if there is growth With $364 billion reportedly raised by private equity funds and we can exit at a good price.” through September, and with them being on pace to have The firm has investments across 100 real estate funds in brought in $468 billion by the end of the year, the firm sees both primary and secondary sides of the trade. plenty of incoming opportunities. That is the largest annual But Wilkins says Aberdeen has a lower number of inflow of capital for traditional funds since 2008, according investments per investment professional than some of its to data from investment advisory firm Triago. competitors. “That allows us to do a lot more due diligence As such, when asked if Aberdeen will launch another secwork. ondaries fund soon, Wilkins says: “It is something we are “This is very important, because when one of our investdefinitely looking at. We expect to be doing more in secondment team presents a potential idea to the investment ary transactions going forward.” committee, part of our responsibility is to explain why we That would further evidence its conviction that in today’s believe in the potential of the investment. Without input pricy primary marketplace secondaries will likely trade, from our research and strategy team and the forecasts even at low to no discount. from our financial models, it would be very difficult for the THE SECONDARIES REPORT 2015 | PERE

15

GUEST COMMENTARY | THE EDITOR’S PERSECTIVE

Hopes and concerns of a staple diet Stapled transactions are a growing phenomenon in the private equity secondaries market, writes Secondaries Investor editor Marine Cole, but not everybody is excited about them Stapled deals – which typically Not everyone, however, is happy about the widening adopinvolve the buyer of a limited tion of stapled fund transactions. An SEC official speaking partner interest also making a comat a recent industry conference signaled the US regulator’s mitment to the general partner’s interest in stapled secondary deals. Do they create situations new fund – have been around for where fiduciary duty may be skirted, he asked? a long time. But they’re becoming Stapled transactions only represent 5 percent to 8 percent more common. And not only has of secondaries deals. But they arguably bring a set of risks the frequency increased, they are that are probably not in the best interest of investors, said also becoming more organized. a person familiar with the SEC’s concerns, adding there’s The archetypal stapled transacsomething “structurally wrong” with them. tion used to occur when a major The regulator’s concerns relate to two points in particular. limited partner wasn’t re-upping in a follow-on fund for First, there’s a worry that GPs seeking – or indeed, in some strategic reasons, such as a decision to stop investing in cases, demanding – staples as a part of any secondaries sale private equity or rebalance its exposure to certain sectors or aren’t fulfilling their fiduciary duty, but are instead putting regions. the interests of the firm and raising the next fund before that In those situations, advisors acting on behalf of the LP of existing limited partners. A GP putting restrictions on an would find a new investor to purchase existing LP stakes in LP is entirely selfish, one person said to me. He said the GP is the manager’s old funds, while also ‘stapling’ a commitment putting its LPs at a disadvantage. to the GP’s latest fundraise – either because it was demanded The other concern is an extension of the first, and has to by the GP or because the new LP was keen on the latest fund, do with whether a GP is as fully transparent as it can be and too. Staples are still happening for those should be with existing LPs when negotiating reasons. a stapled deal. And so staples must be evalu“Staples can be But they have also become a tool for GPs a good thing if done ated carefully on a case-by-case basis by all to revamp LP bases. In some cases, it’s for parties. Some private equity firms indeed do right. Ideally, a poorly performing funds that have encounmodel out the impact of a staple, or unfunded stapled secondary tered problems post-GFC and existing commitment portion of a secondaries deal. should combine investors don’t want to re-up. Whether that That includes controlling which LPs come the highest price in fund is technically considered a zombie, or into their funds on a secondary basis. the bid-ask spread it’s managed by a GP that otherwise has a The circumstances surrounding a stapled and a guaranteed good track record, the secondaries market transaction can vary greatly. When part of a continuity of LPs.” has shown it can help facilitate a difficult fund restructuring process – which the SEC fundraising process. has recently flagged as an area of interest – Then there are the GPs without any problems at all that existing LPs are typically presented with several options want a speedier and more efficient fundraising process. A ranging from accepting the offered price and walking away, staple can help create momentum and secure capital for a to rolling their interest into a new fund under new terms first closing. In these cases, secondaries buyers aren’t just while suffering dilution. If the secondaries buyer is putting filling a hole left by one LP; they’re typically offering liquidin fresh capital, it clearly benefits the GP which now has ity to all the existing LPs in older fund(s) and committing more runway. fresh capital to the GP’s latest fundraise. Staples can be a good thing if done right. Ideally, a stapled The other marked difference is these transactions tend to secondary should combine the highest price in the bid-ask be GP-initiated, which sources say is understandable as manspread and a guaranteed continuity of LPs. Then everybody agers try to be more proactive, strategic and organized in the wins. But be warned, the authorities have taken note of the way they fundraise. There’s a lot of sense in the practice. practice and may need convincing. 16

PERE | THE SECONDARIES REPORT 2015

This announcement appears as a matter of record only.

Final Close: $437,700,000

Portfolio Advisors Real Estate Fund V (“PAREF V”) A global private real estate fund formed to make investments in Primaries, Secondaries and Co-Investments.

September 2015

Portfolio Advisors, LLC is an independent, employee-owned firm with over $34 billion in assets under management. The firm provides a full range of global private real estate, private equity and private debt investment advisory and portfolio management services to qualified investors around the world.

Darien, Connecticut

Zurich, Switzerland www.portad.com

Hong Kong

GUEST COMMENTARY | THE INVESTOR RELATIONS MANAGER’S PERSPECTIVE

Valuation the topic, always Real estate secondaries valuation is in its infancy, but more specialized advisors will lead to greater reliability, writes Morag Beers, former investor relations executive at Composition Capital With the increasing volume trading Certainly some believe that issues with pricing will ease in real estate fund secondaries, there once there are more established and specialized brokers which has been greater scrutiny on pricing are geared up to be making these calculations on a regular and how it is agreed. basis. Naturally, with more such specialism in the marketplace In good old-fashioned property that will lead to greater clarity when it comes to valuation. terms, a fund secondary is akin to Thankfully, such specialists are growing in number in tandem selling a lease. One occupier (read: with the wider real estate secondaries market and so the better investor) holds an interest in a data is incoming. property (read: fund) which they no Another facet of real estate secondaries sophistication is longer wish to hold and agree to sell the fact that there are today many more recognized catalysts to another occupier (investor) – a for transactions than ever before. Whereas before, the reason straightforward transfer of a legal interest in the original lease for a trade invariably involved some form of distress, that is (fund) agreement. Just as ‘lease for sale’ is not uncommon in not always the case today. Moreover, catalysts for trades can property markets, ‘fund interest for sale’ is finding its place in include positive, or at least non-negative, reasons such as an indirect real estate. Underwriting and negotiating the sale of investor’s simple desire for greater liquidity. That will more a lease is quite straight-forward even for the average property than likely see more valuations at lower discounts and, as professional. such, should be considered to be more reliable. The techniques for valuing the lease interest, and coming to Furthermore, I imagine this greater transparency will also a fairly balanced level of lease premium or discount, however, lead to lower fees and other associated costs as currently the are an art form which often rests with additional costs involved in selling a the valuation specialists. secondary fund interest are also an “Before, the reason for And so is this situation mirrored in issue investors are sensitive to. Some a trade invariably involved the real estate fund secondary market: investors have reported being caught some form of distress, that is underwriting may be lengthy but it is out by the final terms of a secondary not always the case today. understandable for investors. It can be sale: what sounded like an interesting Moreover, catalysts for processed. The legalities of the transfer prospect at the outset did not conclude trades can include positive, itself are reasonably straightforward so. By which time of course, the deal or at least non-negative, too. But agreeing a price which could reasons such as an investor’s was so close to concluding in line with be described as fairly balanced between a policy instruction that it was better to simple desire for greater the seller and buyer is something which conclude a less advantageous deal rather liquidity. That will more than arguably requires the input of a specialthan pull out. These early experiences likely see more valuations ist, if a horse deal is to be avoided. have left a slightly bitter taste with some. at lower discounts and, as ‘Valuation is the topic, always,’ an The nascent secondaries market is such, should be considered investor once told me. It often reflects being greeted positively by both investo be more reliable.” the balance of negotiating power tors and fund managers. But while it is between the buyer and seller more than unlikely to develop beyond a niche prothe value of the interest being traded. Given the fund indusgram, its role is welcome and is a vital one. So I can’t see initial try itself is, relatively speaking, still young, when it comes to disappointments and teething issues relating to values, pricing valuation, the even younger secondaries market is behaving and costs dampening investors’ interests in the developments. as you might imagine: with a fair bit of trial and error. To put And with increasing numbers of specialist advisors on hand to it as diplomatically as I can: for now there are deals which are smooth out the fraught issue of valuing interests and brokerbeing settled at prices which may or may not reflect the inhering a balanced deal, it really is a case of onwards and upwards ent value for the interests being sold. from here. 18

PERE | THE SECONDARIES REPORT 2015

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KEYNOTE INTERVIEW | GREENHILL COGENT

No third wheel Successful secondaries transactions depend not only on alignment between buying and selling LPs but with GPs too, say Greenhill Cogent. By Florence Chong Three to tango: the GP must approve deals, not only the buyer and seller

T

he universe for the global real estate secondaries market has undergone considerable transformation over the past five years as it steadily gains acceptance from investment managers and their investors. But while the sector in general has gradually shifted into the consciousnesses of many private real estate investors, a key turning point has come from a change of mindset among general partners (GPs) towards the trading of secondaries within their funds. Indeed, today GP-led restructurings and tender offers are expected to play an increasing role in the future real estate secondaries market, according to Greenhill Cogent, an advisory firm focused on the space. It says GPs are also starting to recognize the role of the secondaries market as a forum to create liquidity for existing investors in older vintage funds. As such they are warming to the idea of secondaries as they see transaction volumes increase and build up experience with LPs who bought into their funds through the secondary market. “GPs are becoming more understanding of LPs needing or wanting liquidity before the end of a fund,” says Andy Nick, principal at the firm. “And they understand that portfolio management is here to stay in the alternative investment world.” Indeed, GPs themselves are coming to the market when they require liquidity to make distribution to LPs who need to leave

20

PERE | THE SECONDARIES REPORT 2015

a fund. Nick offers this scenario: if a fund is 10 years or 12 years old, and the GP believes that value can be maximized by extending the term by a few years, some LPs may not be able to stay in for the extended period. They may be funds of funds whose own vehicles need to be wound down. In such a situation, GPs now turn to the secondary market to solve a liquidity problem. This change in approach reflects a significant leap of faith in the secondary market on the part of GPs, which, until five years ago, might have been taken aback when one of their LPs needed to sell secondary units. “In those days, when an LP called to say it wanted to sell out of a fund, the GP might feel that the LP was dissatisfied with his performance, and would often take it personally,” says Nick. At the time, even the GPs themselves needed an ‘education process’ on these transactions, as real estate secondaries were few and far between.

Key component The process of selling secondaries is complex and much more hands-on than selling a company or a physical piece of real estate. “The GP is a key component in a sale,” says Todd Miller, a managing director with Greenhill Cogent. The co-operation and consent of the GP is crucial in each of the three phases of a transaction: pre-marketing, marketing and closing. Nick explains that at the outset it is necessary to

if an activist investor or an LP which is not likeminded, gets ensure that the GP is comfortable with the marketing process onboard. Nick says GPs are more sensitive today to ensuring and agrees to a robust buyers list. that ‘activist’ LPs are not permitted into the LP base as a result Further, confidentiality is necessary to ensure that imporof a transfer. tant financial information does not fall in to the hands of a If you get a buyer into your fund, which is not supportive of true competitor. Part of an advisor’s role is to vet potential extensions, for instance, it might try to stir up the LP base and purchasers to ensure that a firm that runs secondary funds take the lead to force the disposal of assets or a restructure of and also owns direct real estate – such as many bulge bracket a fund. investment banks – have proper internal controls to prevent Credit-worthiness and the financial capability of buyers are the sharing of information between the different divisions in also factors that GPs consider. They need order to protect the GP’s sensitive confito be assured that when there is a capital dential information. “It’s our job to make sure call, the replacement LP can meet his Nick says: “It’s our job to make sure that the general partner obligations. that the general partner is comfortable is comfortable with the Under US tax laws, most funds are with the parties that we bring to the buyparties that we bring to the classified as partnerships, which enjoy ers list and that they aren’t people the buyers list and that they tax benefits but can be limited to being GP would view as competitors as they aren’t groups the GP would able to transfer no more than 2 percent of might own similar properties in the same view as competitors.” the partnership in a given year, subject to geographies.” various safe harbor provisions. As such, Miller says the advisor might Nick explains that GPs need to be careful that the number request to bring 25 or more bidders to the process, but the GP of transactions does not exceed the statutory limit. Otherwise, might prefer to permit only one or two bidders. “Obviously, if the Internal Revenue Service (IRS) could reclassify a partneryou want to run a competitive process you really want to have ship as a corporation and tax it accordingly. a larger number rather than just two bidders. So working with Next is the issue of foreign investors. Nick says a good examthe GP to make that list as broad as possible and the informaple is a fund holding oil and gas leases, which, under US laws, tion as robust as possible is the key to a successful sale,” says restrict foreign ownership. “GPs have to make sure that they Miller. don’t trip up those foreign ownership rules by He explains that it is the prerogative of the GP permitting a transfer to a foreign entity,” he says. to choose with whom he shares the information. Secondary transactions are unique because But, he says: “If I had $10 million worth of sellers and buyers may agree on a deal, but withassets to bring to market, potential investors out the GP approving the transfer, there can be would want to review the financial records to no transaction. find out how that $10 million is made up. The GP Deals have historically been known to fall has to agree to disclose that information.” over because the GP refused to sanction the An adviser like Greenhill Cogent can offer transfer, although this rarely happens if advisadvice to a diverse group of buyers – from ers are used in the transaction. The advisers vet secondary funds and funds of fund to non-trapotential buyers beforehand, including them in ditional buyers, like pension plans, endowments Nick: GPs are better a sale process. and family offices, says Nick. Miller adds: “If embracing of secondaries Greenhill Cogent handles a wide range of we are able to go to the GP and say that we trades today transactions, starting from small $5 million could replace the LP with a new investor like a single fund transactions to portfolios of 100 or sovereign wealth fund, the GP might be more more funds with a value of more than $2 billion. accommodating in opening up his book. Since 2001, the firm has advised on nearly $140 billion “When someone goes into a partnership, they sign up for worth of transactions across the spectrum of secondary marthe next 12 or even 15 years. So when the current LP wants to kets. However, real estate secondaries only started to figure leave the partnership, the GP wants to know who the replacemeaningfully in its transactions from 2011. ment buyer or buyers will be.” With greater engagement from the GP fraternity than ever Trouble shooting before, the firm expects its real estate secondaries practice only The caution of a GP lies in the risks he can potentially face to get busier in the years to come. THE SECONDARIES REPORT 2015 | PERE

21

ROUNDTABLE | SECONDARIES

Photography by Donald Bowers

Greater awareness Secondaries investing has some way to go before it is fully understood by the private real estate universe. Secondaries Investor editor Marine Cole hears how, bit by bit, education about the sub-asset class is spreading.

(L to R) Kenneth Wisdom, James Sunday, Philip Barker

T

he real estate secondaries market is a niche market, sometimes inefficient and often misunderstood. But it is in the midst of a significant expansion as market participants become more familiar and comfortable with its intricacies. On a sunny fall Monday morning in November, a group of real estate secondaries professionals gather at the offices of property services giant CBRE in the imposing MetLife building that sits on top of Grand Central station in Midtown Manhattan. They include Philip Barker, senior managing director at CBRE, Jamie Sunday, a partner with Landmark Partners, and Kenneth Wisdom, a managing director with Portfolio Advisors. Over the course of almost two hours and multiple coffees, the trio discuss many items. Of high importance to them is what is fueling interest in real estate secondaries, whether large transactions, which have multiplied this year, will find buyers, and what the future holds for this burgeoning sub-asset class which revolves around the transfer of limited partnership fund stakes as well as the restructurings of primary real estate funds. Their faith in the strength of the market and in the ability

22

PERE | THE SECONDARIES REPORT 2015

to get deals done was actually confirmed less than a week later when Blackstone’s Strategic Partners and the California Public Employees’ Retirement System announced the pension plan had sold a $3 billion portfolio of real estate fund interests to the secondaries business of the New York-based sector behemoth. Nonetheless, despite headline-grabbing transactions like that, private real estate secondaries today remains an emerging sub-asset class that requires something of a streamlined definition. Today, there are varying definitions and, accordingly, assets and deals are interpreted in different ways. For CBRE, secondaries transaction volumes in 2014 reached close to $8 billion globally. That represents one of the highest readings of the sector. But then CBRE takes into account all real estate strategies, including core, in which, as an advisor, it has been very active at facilitating transactions. Core funds typically invest in stable multi-tenant properties that provide low risk but also lower returns. Traditional real estate secondaries buyers, on the other hand, focus on higher return strategies. “Generally speaking, I think it’s fair to say that in our numbers, there’s a lot of core business that takes place and those aren’t included in the numbers that opportunity and

value-add secondary players would necessarily look at,” says According to Landmark, growth of the secondary market is Barker. CBRE’s real estate secondaries team, has been facilitata function of the base of net asset value currently held across ing the transfer of many core fund stakes in the UK and in the real estate universe. Every year, a small percentage of this Europe, and has now expanded in the US. NAV trades. The long-term average ‘turnover rate’ has averSunday agrees that it is fair to segment the real estate secaged around 0.6 percent compared to 1.5 percent in private ondaries market in two due to the frequency with which these equity but has been increasing in recent years as more real core positions trade, especially in Europe. As a traditional secestate LPs have been embracing the secondary market to manondaries buyer, however, Landmark typically excludes core. age their portfolios. The real estate turnover rate hit 1 percent Accordingly, the firm tracked $4.8 billion globally in comin 2014, according to Landmark calculations. pleted secondaries transactions in 2014. “Over the past six years, real estate “It is a very liquid market and it secondary transaction volume has been “We are at historically high almost acts like a publicly-traded REIT growing at over 30 percent per year pricing for the secondaries market,” Sunday says of the transfer market. That has also allowed and we expect this robust growth to of core fund stakes in Europe. “What continue over the next few years,” says the market to unleash some we’re focusing on is the opportunity set Sunday. pent up demand.” that traditional secondaries buyers are -Kenneth Wisdom Optical pricing going to look at. That typically involves One of the main drivers of supply has core-plus, value-added and opportubeen improved pricing optics, which typically incentivizes nistic strategies.” sellers to sell. Real estate fund stakes priced on average at 92 Regardless of the way transaction volumes are tallied, all percent of net asset value (NAV) in the first half of the year, agree that real estate secondaries is an expanding market according to data from secondaries advisory firm Greenhill and that transaction figures will be higher for 2015. Indeed, Cogent. However, reflected in this pricing is the fact that many Landmark notes volume this year could exceed $7 billion, and of the large deals completed have involved deferred purchase is anticipated that aggregate volume over the next three years structures where payment of the purchase price is paid over could reach $20 billion to $25 billion or more. Meanwhile, time instead of all at closing. This has enabled secondary buyers given its wider net, CBRE reckons that there will be at least to pay higher ‘optical pricing’. Knowing that limited partners $10 billion in volume this year. can achieve attractive optical pricing is a motivating factor in prompting more of them to become sellers. “We are at historically high pricing for the secondaries market,” says Wisdom, head of real estate at Portfolio Advisors. “That has also allowed the market to unleash some pent up demand.” Rising price trends have been driven by recovering real estate fundamentals, improved capital markets liquidity, accelerated distributions and appraisal lag. It is explained that secondaries buyers typically price a transaction based on the NAV from a quarter or two prior to when the transaction actually THE SECONDARIES REPORT 2015 | PERE

23

ROUNDTABLE | SECONDARIES

what that means in terms of the secondaries because they just look at a headline number,” says Barker. “But you have to remember NAV is a backward metric. You’re pricing something based on a NAV that’s one or two quarters back. There’s inherent value there that optically the seller might not always consider.” The use of deferred payments, which allow a secondaries buyer to pay only a certain percentage of a transaction cost at closing and the remainder in installments over several years, has also Sunday: says Landmark closed a sizeable deal with a deferred structure helped create more attractive pricing for sellers. closes. Because fund NAVs are largely appraisal based, they From a seller’s point of view, deferred structures allow them have been lagging current values seen in the direct property to present higher pricing to their board when trying to get markets. Because of this lag, buyers can afford to pay a lower transactions approved. However, such structures also imply discount, hence luring LPs in agreeing on a sale. that sellers have to assume a credit risk and need to be com“When people look at NAVs, they often don’t understand fortable with the creditworthiness of their counterparty.

A field wide open Capital raising and targeting is ahead of where it was but there is a long way to go before real estate secondaries match private equity secondaries Investing in a real estate secondaries fund can be a good way to jumpstart a private real estate program, add vintage year diversification and to mitigate the J-curve, but investors are still shy about hopping into the strategy. “My sense is that if you poll all the major LPs across the US and Europe, a majority of them have or are currently invested with a private equity secondaries manager,” says James Sunday, a partner with Landmark Partners. “If you did the same survey across real estate, it’s probably less than 10 to 15 percent. There’s a lot of green field to court. That’s a very exciting part of our business.” Real estate secondaries is such a new strategy that few investors are even aware of it. But the benefits of investing in a secondaries fund are numerous. Secondaries can help quickly bring diversification to a new program, mitigate risk and accelerate cash flow.

24

PERE | THE SECONDARIES REPORT 2015

“Some investors are recognizing the advantages of being in real estate and of being further down the J-curve,” adds Philip Barker, senior managing director with CBRE Capital Advisors. For investors interested to foray into a real estate secondaries fund, there are some options. Five real estate secondaries funds targeted about $2.34 billion as of October, up from $2.13 billion a year ago, according to data from PERE’s Research and Analytics. In terms of capital already raised, Landmark closed its Landmark Real Estate Partners VII fund in May with $1.6 billion, exceeding its $1 billion target. More recently, Portfolio Advisors closed Portfolio Advisors Real Estate Fund V in October with $437 million, beating its $400 million target. The firm can invest 80 percent of it in secondaries and co-investments.

A rising tide

Year

Sunday explained that because of such deferral structures, pricing on a real estate secondaries transactions can vary greatly. “We just closed a sizeable deal with a deferred structure that was a 12 percent discount. Our all-cash price for the portfolio was closer to a 20 percent discount. Deferrals allow you to pay over time, improve the optics for the seller and maintain attractive returns.”

2012

$12633.5m 2013

$4800m

2011

$3691.5m

$12633.5m

$10034.3m

$2599.2m

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

$2166.3m

$7868m

$6057.6m

$1810.4m

$4810.3m

$1247.3m

$855.1m

$590.1m $3955.2m

$961.8m $3365.1m

Cumulative

$349.9m $2403.3m

$211.5m $2053.4m

$378m $1841.9m

$140.3m $1463.9m

$87.8m $1323.6m

$88.8m $1235.8m

$272.2m $1147m

$209.6m $874.8m

$219.6m $665.2m

$445.6m $445.6m

Annual

$21125m

Real estate secondaries transactions have exponentially grown over the past two decades

2014

Source: Landmark Partners

“It used to be that if you sold on the secondaries market it was a taint, because you admitted you were not a long-term investor in what is a long-term asset class,” Wisdom says. For him, that mindset has changed in recent years. In 2012, the state of New Jersey was the main reference for

Losing the taboo With high pricing and more investors showing that they can close large transactions, new sellers are entering the market and are becoming more comfortable with it. Historically, the secondaries market was somewhat associated with distressed sellers and it was typically taboo to advertise a sale. This was especially the case in the immediate aftermath of the global financial crisis, when investors had no choice but sell at very low pricing due to a need for liquidity.

Wisdom: selling secondaries used to viewed as a taint

THE SECONDARIES REPORT 2015 | PERE

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ROUNDTABLE | SECONDARIES

BIOGRAPHIES

Philip Barker Senior managing director, investment banking CBRE Capital Advisors Barker, who spent most of his career as a trader, joined CBRE in January to focus on facilitating real estate secondaries transactions. He previously served as global head of precious metal trading for ICAP and also worked at GFI focusing on real estate alternative investments, commodity structuring and derivatives. CBRE Capital Advisors has facilitated about $6.5 billion in secondaries trades.

James Sunday Partner Landmark Partners Sunday joined Landmark Partners in 2006. He is responsible for sourcing, underwriting and executing real estate secondaries transactions. In his career, Sunday also worked as an associate for Citigroup Global Markets, focusing on the execution of mergers and acquisitions across the real estate and lodging sectors. Landmark Partners has more than $15 billion of committed capital, including more than $3 billion in real estate.

Kenneth Wisdom Managing director Portfolio Advisors Wisdom has been with Portfolio Advisors for 13 years and serves a lead member of the firm’s real estate investment and advisory team. Prior to joining Portfolio Advisors, he founded PrivateTrade, a private equity secondaries advisory firm. He’s also served for the University of California Office of the Treasurer and for the Massachusetts Pension Reserves Investment Management Board. Portfolio Advisors has $35 billion in assets under management.

26

PERE | THE SECONDARIES REPORT 2015

large real estate secondaries sales when it sold nearly $1 billion to mortgage real estate investment trust NorthStar Realty Finance and Goldman Sachs Asset Management. This year, the frequency of large deals has picked up significantly. For instance, Harvard Management Company offered $1 billion of real estate fund stakes earlier this year and managed to sell about half of it. CalPERS’ $3 billion portfolio was bought by Blackstone, and the Government of Singapore Investment Corporation is currently in market with a $1 billion transaction, which had not closed at press time. “The secondaries market has gained so much acceptance,” says Barker. “We’ve seen CalPERS come to market with a very large portfolio of $3 billion. That’s going to create the impetus for other large pension funds to say ‘look, maybe there’s some things we can do too.’” No longer in dire need of liquidity as they were six or seven years ago, investors today have other reasons for tapping the secondaries market, the main one being portfolio rebalancing. Wisdom explains that it is very common for someone taking a job at one of the large investors to inherit an over-allocated exposure to real estate, forcing them to look to rebalance. “With an illiquid portfolio, it’s only the secondaries market that provides that opportunity,” he says. “Now if you are receiving large distributions from funds you are invested in, it might take care of itself, but maybe not quickly enough.” Investor fatigue is also often cited as a reason to sell. Many investors invested large sums to real estate funds between 2005 and 2007 and saw valuations written down, in some cases to as low as 20 cents on the dollar. If they were not forced to, they most likely did not sell at the time. Now the valuations have been written back up, but divestments occurred at a much slower pace than expected. “They’re now in year 10 and beyond and they’re coming to market saying ‘I’d rather liquidate this portfolio now and take most of my money off the table and redeploy it somewhere else than hold on it for another two, three or four years,’” Wisdom says. “The investor fatigue creates an interesting dynamic where tightening bid/ask spreads in the secondary market could help to achieve that goal.” Funds of funds have also emerged as sellers of real estate fund stakes, particularly this year. Generally speaking, they want to clean up older funds, called tail-end funds, which only have a few remaining investments. Assets in tail-end funds are usually well beyond their value-added or execution plan so they tend to go at a steeper discount since there’s not much upside left in those investments. With the rise in supply, it is only natural to wonder whether there is enough dry powder in the market to actually purchase all the fund stakes that are supposedly for sale, particularly the large portfolios. Groups that can purchase large portfolios are few beyond the likes of NorthStar, Goldman Sachs, Landmark and Blackstone’s Strategic Partners.

Funds of funds managers including Portfolio Advisors and Partners Group have also increased their exposure to secondaries in recent years. Two years ago, the Carlyle Group purchased real estate fund of funds Metropolitan Real Estate Equity Management, which is currently raising its first secondaries dedicated fund, targeting $450 million, but instances of corporate acquisitions in the space are still scarce. “We’ve seen an increase in the recent deal flow coming to market,” says Wisdom. “There’s not a lot of additional capital out there beyond the current players to absorb this. So there’s a disconnect between supply and demand. It’s a private market place so it is inefficient. But we’re starting to see that change, with new entrants coming to the market place.” It is rare that a single secondaries buyer can buy a large portfolio on its own, yet, while a portfolio could be broken down, most sellers prefer a single buyer for simplicity of transaction and for certainty of execution. Co-investments have also bridged the gap and allowed traditional secondaries buyers to avoid club deals. In the recent CalPERS transaction, Strategic Partners brought in about 10 investors as co-investors and other buyers are using that tool extensively as well. “We have seen strong appetite for co-invest opportunities on some of the larger deals we’ve completed. This is an effective way to absorb some of the volume in very large transactions,” says Sunday. “Over the past five years, there

were only three real estate secondaries transactions exceeding $400 million of total exposure. This year alone, we have seen six large scale transactions over $400 million that have closed or are in the process of closing.” Landmark, which raised $1.6 billion earlier this year for its most recent real estate secondaries fund, Landmark Real Estate Fund VII, also secured dedicated commitments to a co-investment vehicle from investors, according to filings. The real estate secondaries market is still a few years behind its private equity counterpart, with lower volume and only a fraction of its buyer universe. To further fuel the growth that real estate secondaries has experienced this year, Barker, Sunday and Wisdom all agree there’s a significant need to further educate investors about the benefits of the secondary market from both a portfolio management perspective and an investment perspective. “The hardest thing really has been educating investors that may have invested in and, or, sold in the private equity secondaries market that there is a functioning and growing real estate secondaries market that is a useful tool to manage their real estate fund portfolios and also consider as a strategy to invest in,” Sunday said. Nevertheless, educating investors about the nuances of real estate secondaries is a challenge today’s roundtable is keen and willing to meet. With efforts like this, bit by bit the sector is getting there.

Up for the challenge: PERE’s inaugural roundtable on real estate secondaries accepts the need to educate investors

THE SECONDARIES REPORT 2015 | PERE

27

RESEARCH & ANALYTICS

David versus Goliath Fundraising for private real estate secondaries funds has grown considerably since the global financial crisis but remains far behind the more established private equity secondaries funds. Real estate vs private equity secondaries fundraising since 2008 $bn

29.56

Capital raised US$bn

23.05

21.52

21.54

11.79

11.21

10.67 7.81

2.22 0.30

0.00

2008

2009

Private real estate funds

2010

3.60 1.23 2011

0.20

2.10

0.00

2012

2013

2014

2015

Source: PEI and PERE Research & Analytics

Private equity funds

Top 10 Partners Group and Landmark Partners are the runaway leaders when it comes to private real estate secondaries fundraises but challengers to their early dominance are on the horizon.

Top 10 private real estate secondaries fundraises Target Current Size ($mn) Size ($mn)

Year Close

Region Focus

Fund Sector

$1,950.00 2013

2014

Global

Diversified

$1,000.00

$1,600.00 2014

2015

Global

Diversified

N/A

$1,500.00 2009

2010

Global

Diversified

United States

$750.00

$825.00 2013

2014

Global

Diversified

United States

$750.00

$718.00 2010

2011

Global

Diversified

United States

$400.00

$510.00 2010

2011

Global

Office

AIP Phoenix Global Real Estate Secondaries Fund II 2013

Morgan Stanley Alternative Investment Partners (MS United States AIP)

$500.00

$500.00 2013

2015

Global

Diversified

Aberdeen European Secondaries Property Fund of Funds

Aberdeen Asset Management

$394.58

$394.58 2013

2014

Pan-Europe

Diversified

Phoenix Global Real Estate Secondaries Fund

Morgan Stanley Alternative Investment Partners (MS United States AIP)

$250.00

$370.00 2009

2010

Global

Diversified

UK Real Estate Recovery Fund

Aviva Investors

$385.56

$343.92 2009

2010

Western Europe

Diversified

Fund Name

Fund Manager

Head Office

Partners Group Real Estate Secondary 2013

Partners Group

Switzerland

$1,000.00

Landmark Real Estate Partners VII

Landmark Partners

United States

Partners Group Real Estate Secondary 2009

Partners Group

Switzerland

Madison International Real Estate Liquidity Fund V

Madison International Realty

Landmark Real Estate Fund VI

Landmark Partners

Madison International Real Estate Liquidity Fund IV

Madison International Realty

United Kingdom

United Kingdom

Vintage

Source: PERE Research & Analytics

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PERE | THE SECONDARIES REPORT 2015

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