The announcement by the California Public Employees’ Retirement System that it plans to sell $3 billion-worth of real estate fund stakes comes at an opportune time for secondaries buyers and intermediaries who have been building teams and raising new dedicated funds targeting the sector.
Real estate secondaries transactions, according to Landmark Partners, totalled about $4.8 billion in 2014, up $1.1 billion from 2013 and the sixth consecutive record year. With last week’s news of CalPERS planning to sell $3 billion-worth, representing more than half of last year’s supply, 2015 seems set to see another all-time high.
Several positive repercussions will result from the sale, the most obvious being an increase in the supply of real estate secondaries.
While a transaction of $200 million-$300 million was once considered large, real estate deals over $1 billion are now much less rare than they used to be. Even if CalPERS doesn’t succeed in selling the whole $3 billion and offloads only about $2 billion, it will still be the largest real estate secondaries deal ever.
This is a significant milestone for the market, which hasn’t historically been as robust as that for buyout fund stakes ‑ mainly because it is younger. But with this jumbo deal, the market for real estate secondaries is gaining maturity.
The supply boost won’t come only from CalPERS, but also from other institutional investors inspired to follow suit.
“This is probably going to encourage others to sell,” said a partner at a secondaries firm that invests in a diversity of assets including real estate. “Because they’re so large, a lot of smaller and mid-size pension plans will look and say, ‘Maybe we should do the same.’”
One consequence of having such a large portfolio coming to market is that pricing won’t get out of hand, considering that the quality of the assets will be quite heterogeneous, he added.
Pricing for high-quality real estate secondaries is typically between par and a 10 percent discount to NAV. More medium-quality assets go for about 10 percent to 30 percent discounts. With such a large portfolio, the real estate fund stakes will likely be a mix of good and bad assets, which will be reflected in pricing. “You won’t overpay,” said the investor.
On both sides of the Atlantic, the secondaries industry has been gearing up for such an increase in supply. Evercore recently hired Nishant Bakaya as managing director to advise institutional investors and fund sponsors on transactions in the real estate sector.
“We believe that real estate will be one of the fastest growing areas in the secondary market for the foreseeable future,” Nigel Dawn, global head of Evercore’s private capital advisory group, said in a statement announcing the new position.
In a similar vein, dealer-broker Tullett Prebon has been building a new desk to handle real estate deals on its matching platform, TP-AIME, and has hired Michael McKell to trade open-ended and specialist real estate funds.
On the fundraising side, The Carlyle Group’s Metropolitan Real Estate Secondaries & Co-Investments is seeking $450 million, and Partners Group Global Real Estate, which will invest 25 percent in secondaries, is targeting $1 billion. Other firms that invest in real estate secondaries include Blackstone’s Strategic Partners, Landmark Partners, which closed its seventh real estate fund in May with $1.6 billion, StepStone and LGT Group.
The CalPERS announcement is great news for some of these established players looking to put their dollars to work. However, it may be more difficult for newer entrants to the world of real estate secondaries.
Buying real estate fund stakes on the secondaries market is typically more complex than buying LBO fund stakes and the structures of real estate transactions can be trickier, involving complicated tax issues, especially for offshore investors. Analysing a portfolio of buildings spread across a large geographical area is also generally more intricate and time-consuming than going through a portfolio of companies.
“You need the local knowledge for the assets,” said an investor. “It’s more difficult to evaluate and close. For new entrants especially, it’s a lot harder than people think. Not everyone is built for it.”
This means that despite new real estate funds being raised, it’s likely that the bulk of the CalPERS portfolio will be bought by the strongest groups, according to one member of an advisory firm.
“There are ways to scale those things up,” he said. “They could do a club deal or you could do it in different pieces. You could also bring in a large LP. That’s typically how large transactions get done.”