Europe and Asia play catch-up in real estate secondaries market

It is no secret that the US sets the pace when it comes to new trends or developments in much of the real estate industry. From there it spreads first to the UK and then to other parts of the world. It’s the same with real estate secondaries market trading, in which the US retains its first-mover advantage.

But as the sector continues to evolve and mature, the growth spurts witnessed elsewhere around the globe during the past decade are expected to accelerate. Conditions are now ripe for the fragmented markets of Europe and Asia to step more visibly into the secondaries spotlight.

While the real estate secondaries market is large and expanding, the capital dedicated to this strategy is still limited compared to the broader private equity market. Add to that the cocktail of higher-for-longer interest rates, a broad correction of real estate values and the heightened illiquidity in the current macroeconomic environment, it is little wonder that market players are talking about a highly attractive secondaries execution vintage in the next couple of years.

Senior executives at Ares Management believe annual total transaction volume could even double to north of $20 billion during that period.

Kilian Toms, a managing director in the real estate partners strategy at CBRE Investment Management, says: “As investors at all points in the capital stack grapple with the impacts of higher interest rates and an uncertain macro-outlook, asset values have begun repricing. This has led to a broader impact on their portfolios, which has created a pool of motivated sellers.”

Liquidity release valve

The development of the real estate secondaries market has run parallel with an evolution in motivation. One of the sector’s first inflection points was during the post-GFC period, when investors in particular were selling their interests in fund vehicles due to distress in their broader portfolio allocation.

Toms adds: “They looked to secondaries as a release valve to unlock cash to service need somewhere else in their portfolio. But that market has long gone. Sellers are approaching the secondaries market with much more of a strategic lens on how to optimise or rebalance their portfolios. We’re also seeing more high-quality assets that may not otherwise see the light of the primary market. That is a big and growing part of the market where the considerations are the same as for direct underwriting.”

“Pan-regional strategies have seen the greatest volume growth with investors generally focusing on core diversified products in larger, open-end vehicles”

Sam Whitman
PropertyMatch

In a reversal from the post-GFC period, the volume of manager-led sales nevertheless dominates trading today, accounting for roughly two-thirds of the total, or an average of around 66 percent, according to data from Ares Management.

Data from PropertyMatch, the online real estate secondaries trading platform, indicates Europe is rapidly gaining ground after overtaking the UK just four years ago in terms of transaction volume. Asia accounted for just a small amount, says Sam Whitham, unlisted secondaries broker at PropertyMatch. “Pan-regional strategies have seen the greatest volume growth with investors generally focusing on core diversified products in larger, open-end vehicles and supplementing this with alternative/niche strategies with more specialised managers.”

Real estate secondaries may now be more accepted globally, but it is not necessarily easy going in the fragmented European real estate market, which is inefficient and less transparent compared to US and UK markets. The same is true for Asia.

The other side of the coin is that this fragmentation, combined with markets that move and recover at different speeds, also provides an attractive opportunity set, says Michelle Creed, partner and co-head of real estate secondaries in the Ares Secondaries Group. Sponsors are starting to embrace secondaries as another instrument in the capital solution toolbox for a wide variety of reasons, both in strong and weak market environments, she notes.

“Today’s market environment has further accelerated the utilisation of these liquidity solutions, amplifying the opportunity set in Europe and accelerating the transformative change that we have observed in this region,” says Creed, adding that having boots on the ground is vital. “Local experience is key to unlocking the value proposition at hand and providing better quality, customer-centric real estate solutions to the end user.”

Pan-European universe expanding

Creed says the opportunity set in Europe will continue to broaden, especially now that more and more managers are already gravitating towards the secondary market.

“Given the fragmentation within European markets, we believe sponsors will continue to seek capital and a thought-partner approach that can provide solutions driven by a wide variety of situations that can be very specific to them or the market they operate in, resulting in a dynamic environment for us to operate in,” she explains. “As the universe of both pan-European and country-specific investors continues to expand, we expect to see a continued rise of potential users and further growth of the real estate secondaries market in Europe.”

In terms of sector focus in this part of the world, Ares Management has been most active in logistics and industrial, self-storage and rental housing, including student accommodation, due to favourable occupier and customer trends. Creed also sees opportunities within subsectors of hospitality that are starting to price attractively while demonstrating continued strong growth in customer demand.

While the European market has steadily gained ground in the past decade, there is still considerable room for further expansion, according to Achal Gandhi, CIO, indirect real estate strategies, at CBRE Investment Management. Annual secondaries transaction volumes tend to track capital raised for private equity real estate funds and are commonly estimated – at a high level – based on outstanding net asset value owned within these funds. Based on MSCI data, the privately-owned real estate market size in Europe has expanded at a slower pace than the US, he points out.

“Over the past seven years, the private market-owned NAV in Europe has increased by 6.3 percent, whereas the US grew at 7.4 percent. Europe continues to trail,” notes Gandhi. “That said, we see a continually growing opportunity set to work with both European limited partners and operators who are looking to reposition their real estate portfolios. They are increasingly using the secondary market as a tool to facilitate that effort.”

Asia at a pivotal juncture

The real estate secondaries market in Asia is even less developed than in continental Europe but finds itself at a pivotal juncture. Asia’s current stage of evolution mirrors the nascent phases of the European market about six to seven years ago, and it is now poised for significant expansion over the next five to 10 years, says Creed. “That optimism is grounded in the understanding that the primary market’s current size is akin to Europe’s market size during that period, but also uniquely amplified by today’s transactional and market environment.”

Asia’s growth trajectory could potentially even surpass that experienced by the US and Europe due to the current market dynamics and broader awareness of the secondary market, she adds. “The Asian market is still in its early stages of development and as such has experienced expansions and contractions over the past decade. Given both supply and demand factors, we believe that the Asian real estate secondary market will grow and start to gain critical mass over the next several years.”

The current slow transactional environment, coupled with investors’ diminishing patience for managers to repatriate capital, underscores a critical catalyst for Asia’s secondaries market growth, Creed says. “This scenario is prompting both LPs and GPs to explore secondary transactions as a strategic solution to liquidity needs and portfolio optimisation.”

Natural growth markets

With utilisation of the secondary market set to increase globally, Europe and Asia both represent natural growth markets, notes Gandhi. “Most commonly, real estate secondaries funds are deployed via a global format. Increasingly, the dedicated secondaries specialists have set up regional teams in Europe, and recently, have started to focus more on Asia.”

In Asia, PropertyMatch’s Whitham is seeing significant growth in the core, open-end structures. “With a smaller number of available products and a growing interest from global investors, we have seen less selling interest as unitholders retain their Asia exposure for diversification. Diversification appears to be the main focus globally, with investors moving away from country-specific funds.”

As in Europe, and the US for that matter, the most promising sectors for institutional investors in Asia are those experiencing fundamental growth and maturity, such as logistics and industrial, and residential, says Creed. She explains that in terms of location, Ares Management is finding pockets of opportunities across the board in Asia, with developed markets like Australia and Japan standing out due to their advanced primary markets.