Sarah Schwarzschild and David Lei, from Carlyle Group subsidiary Metropolitan Real Estate Equity Management, discuss drivers of RE secondaries deals, GP-led transactions in the asset class and their approach to Brexit.
Congratulations on your inclusion in the SI 30 ranking of the biggest fundraisers. How would you characterise the past year in terms of RE secondaries dealflow? What types of transactions have been keeping you busy?
Thank you! Metropolitan has been busy globally with our investment activities in the US, Europe and Asia being relatively balanced. Our investment strategy also spans traditional secondaries, asset recaps and more structured situations. Over the past year, we have seen an uptick in the quality of dealflow for asset and structured secondaries in particular.
What have some of the drivers been of sellers of RE fund stakes this year? What has pricing been like?
The sale of real estate fund stakes continues to be driven largely by portfolio management. This often includes changing allocation targets and efforts to reduce manager relationships. The arrival of new senior leadership can also be a catalyst for transacting.
According to Greenhill, the average pricing for real estate secondaries was 83 percent of reported net asset value in H1 2019, which is a drop from 89 percent through 2018. Some of this drop may be a by-product of large transactions that can significantly skew the average. We believe that higher-quality, newer vintage assets with potential upside continue to trade at more modest discounts.
How active is the GP-led restructuring market for real estate and how do the drivers of these deals differ from those in private equity?
The GP-led market has grown to be active in the past few years – for fund restructurings as well as more focused recaps of individual deals. Real estate GPs are increasingly familiar with the secondary market and how it can help them manage their portfolio while providing liquidity options for investors at suitable points in time.
We find that the drivers for GP-led deals in real estate differ from those for corporate private equity. Real estate is a more liquid asset class. In this market environment, GPs can generally sell their properties even if they are working through a change in the business plan. It isn’t enough for GPs to want to hold assets longer. We’re looking for a real opportunity to add value going forward.
How has Brexit affected the types of deals you’re looking at? Are you staying away from exposure to UK property?
It is very much a wait-and-see situation in the short term with negotiations between the UK and EU remaining ongoing. We have longstanding UK specialist manager relationships and a local team in London, so we believe we are well-equipped to capitalise on any potential investment opportunities that may arise as a result of the changing political landscape and its impact on real estate values.
Are there any big growth areas in RE secondaries on a regional or strategy basis?
We see growth and opportunity in core-plus secondaries. According to Preqin data, there has been a significant increase in the number of core-plus funds raised annually since 2009. Many of Metropolitan’s value-add and opportunistic managers now also offer core-plus funds, SMAs and individual deals. Naturally, we’re starting to see stakes in closed-ended core-plus funds sell on the secondary market. We’re also finding attractive deals to recap assets that were originally acquired as value-add or opportunistic investments. These assets have executed their business plans with great results for the original investors but can continue to offer both cashflow and upside on a de-risked basis. We are actively evaluating transactions in both strategies.
How competitive has the RE secondaries space become this year? Are you seeing a range of new entrants such as traditional LPs active on the buyside?
The competitive landscape is relatively stable. The barriers to entry can be high for new secondary funds. GP relationships, which are critical to continually sourcing and underwriting deals, can take a very long time to develop. And very few traditional LPs are active on the buy side, though we occasionally see one-off transactions get done. Secondary transactions tend to move very quickly and can be relatively complex in structure, so we believe dedicated global teams are important to succeed.
Sarah Schwarzschild is a partner and co-head of Carlyle’s real estate multi-manager platform. David Lei is a principal and a member of the unit’s investment team. Both are New York based.