Call it the stars aligning or a perfect storm, but the convergence of factors in the commercial real estate investment and private equity markets is leading many to see the sun shining on real estate secondaries.
These factors include macroeconomic trends like rampant inflation and surging interest rate; falling valuations of real estate assets causing a denominator effect in mature portfolios; and large bid-ask spreads preventing buyers and sellers from aligning on transactions. Also contributing to this are the differences in performance across sectors and regions that in turn demand greater due diligence to identify a property’s future value amid changing ESG requirements and occupier needs.
Despite a slight pull-back in completed real estate secondaries transactions in 2023, according to data from international alternative investment manager Ares Management, supply has never been larger and the need for capital remains sky-high. As a result, the real estate secondaries market is expected to accelerate in the coming years with a broad pipeline of deals emerging.
According to data from global financial services advisory and asset management firm Lazard’s private capital advisory group, the majority of investor-led real estate secondaries portfolios were sold in North America, where pricing remains strongest. Meanwhile, pension funds and financial institutions were the most active sellers in the secondaries market as they looked to rebalance investment portfolio allocations in 2023, and an increasing number of family offices explored secondaries market sales to meet liquidity needs.
Investors and managers alike are seeking liquidity in today’s market, leading to increases in both manager- and investor-led deals across the asset class. Investor-led transactions saw a marked increase over the past year, even while manager-led deals continue to dominate the landscape.
Continuation funds are also gaining popularity for managers and investors willing to navigate their complexities. The US holds the lion’s share of completed secondaries transactions, but specialists in Europe’s and Asia’s fragmented markets are seeing opportunity for growth, especially with significant debt maturities creating opportunities for recapitalisation.
Fundraising for the secondaries strategy continues to climb as well. Data from Secondaries Investor reveals that funds which held final closes for secondaries across all asset classes hit $117.92 billion in 2023, more than double the prior year’s $53.28 billion total.
Real estate-focused secondaries funds also grew as a proportion of capital raised, accounting for 7 percent of last year’s total, up from 2 percent in 2022. They attracted $8.37 billion last year, compared with 2022, when roughly $940 million was raised for the real estate asset class for private, closed-end vehicles. Overall, the real estate secondaries market is poised for significant growth, driven by increased demand for capital, attractive discounts to net asset value and a broadening range of transaction types.
Beyond the big picture, several other key trends have emerged as investors see an opportunity to provide much-needed liquidity in the traditionally illiquid real estate market.
1 Expanding into Asian markets
The real estate secondaries market in Asia is in a state of evolution, although it lags behind more established markets in terms of development. Traditionally, Asian investors have favoured direct investments or conventional real estate funds over secondary market opportunities. However, this stance is gradually shifting as investors face challenges like slower distributions and the need to rebalance portfolios, prompting a growing interest in secondaries transactions.
The emergence of continuation funds has been instrumental in facilitating this transition. These funds offer existing investors the option to either exit their investments or roll them over into new funds, providing flexibility and liquidity. For managers, continuation funds present an opportunity to retain capital and optimise asset performance over a longer horizon.
Navigating the Asian real estate secondaries market presents unique challenges, with transactions often being bilateral and requiring a deep understanding of the needs and motivations of both investors and managers while navigating disparate local markets. Nonetheless, the momentum in this region is unmistakable, driven by a growing pool of investors and managers in the sector.
2 Continuation of strategic solutions
Continuation funds have gained traction in the real estate secondaries market, offering a strategic avenue for both investors and managers. These funds allow investors to maintain existing exposure or gain new entry to a mature portfolio of high-quality assets while addressing liquidity needs of investors looking to exit a fund nearing the end of its lifecycle.
In a win-win situation, managers gain an opportunity to optimise asset performance and align with investors’ objectives and business plans over a longer timeframe.
Continuation funds offer stability and flexibility in uncertain markets, allowing investors to navigate volatility and manage risk. By extending the investment horizon, these funds enable strategic initiatives such as asset repositioning and capital improvements, driving incremental value for investors.
However, successful implementation of continuation funds requires clear communication, transparency and alignment of interests between all parties. Additionally, careful consideration of fund terms and conditions is essential to ensure a mutually beneficial outcome for all stakeholders, as is strong understanding of the individual assets and local markets a new investor is accessing.
3 Sector selection and performance
Sector preferences play a crucial role in shaping investment strategies and driving performance in real estate secondaries markets. Sectors such as data centres, digital strategies and industrial properties have emerged as key drivers of activity, driven by strong demand fundamentals and resilient income streams.
Conversely, the office sector has faced challenges amid remote work trends and changing workplace dynamics. While certain submarkets may present opportunities for value creation, the overall outlook for the office sector remains subdued compared to other property types. Retail, on the other hand, is gaining popularity among investors that have sat out of the sector in recent years.
Navigating sector preferences requires a disciplined approach, focusing on sectors with strong demand fundamentals and favourable supply-demand dynamics. Diversification across sectors and geographies can help mitigate risk and enhance portfolio resilience, while strategic asset selection is essential for capturing value in a competitive market environment.
4 Pricing and risk management
Pricing remains a key consideration in the real estate secondaries market, with bid-ask spreads and valuation discrepancies posing challenges for investors across the real estate sector. While preferred sectors may command premium pricing, other sectors may face downward pressure on valuations.
Mitigating risk in real estate secondaries across the risk spectrum requires rigorous due diligence and proactive risk management strategies. Investors must conduct thorough assessments of individual assets, including property-level cashflows and market data analysis. Understanding the capital structure and performance of underlying assets is critical for assessing risk and evaluating potential returns.
Additionally, investors must evaluate macroeconomic factors and geopolitical risks that could impact real estate markets globally. By maintaining a diversified portfolio and staying attuned to market dynamics, investors can effectively navigate pricing challenges and mitigate downside risk. Of particular concern is assessing the discount price inherent in providing liquidity and deciding to what extent an offered discount is true value compared to future pricing.
5 Shifting dynamics and opportunities
The real estate secondaries market is experiencing a shift from investor-led to manager-led transactions, driven by changing investor preferences and market conditions. Manager-led transactions offer several advantages, including better asset selection and alignment of interests between managers and investors.
Moreover, the current market presents unique opportunities for private equity investors to capitalise on liquidity constraints and inefficiencies in the primary market. Real estate secondaries funds are experiencing heightened demand, creating opportunities for value-oriented investments.
Looking ahead, the real estate secondary market is poised for continued growth and innovation. As the market matures, investors must remain vigilant and adaptive, seeking out opportunities that offer attractive risk-adjusted returns and align with their investment objectives.
Navigating real estate secondaries markets requires a strategic approach, informed by sector insights, pricing dynamics and risk management strategies. Through this, investors can unlock value in an evolving landscape.
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