Move over, debt funds – RE secondaries are driving appetite, too

Two historic fundraises in the space of a week tell us much about where real estate investors see opportunities for returns in a fractured market.

In less than a week, private real estate has seen not just one but two of the largest fundraises of the year take place in the secondaries corner of the market. Amid a prolonged and industry-wide fundraising slowdown, these final closes are large not just for the strategy, but also for real estate as a whole.

Ares Management’s $3.3 billion haul for Landmark Real Estate Fund IX, in addition to co-investment, represents the joint-largest fund ever raised for real estate secondaries. It shares this title with the eighth fund in the same series, which closed in 2018, according to data from affiliate title PERE.

While Ares’ latest offering fell short of its $3.5 billion target, it is nevertheless the fourth-largest real estate fund of any strategy to reach a final close so far in 2023. In a year when private real estate fundraising for Q1-Q3 was at its lowest level for a decade, per PERE data, and down 35 percent on last year, the fundraising is significant.

Yet Ares is not alone in this particular achievement. Fellow US mega-manager Blackstone also said, only a few days prior to Ares, it had closed its latest real estate secondaries offering, Strategic Partners Real Estate VIII, on $2.6 billion. That fund is the seventh-largest real estate fundraise of 2023 thus far.

As we approach the end of the market cycle and the sector’s need for liquidity intensifies, this level of institutional appetite for secondaries is not surprising. For many managers, refinancing debt in a higher-for-longer interest rate environment exposes a significant capital shortfall with existing loan maturities, creating an opportunity for capital solutions providers to step in and fill the gap.

Indeed, according to Jamie Sunday, partner and co-head of real estate secondaries at Ares, while the pipeline for Fund IX is diversified across manager-led opportunities and investor portfolios, the former represent a larger component of overall dealflow at present as managers look to address liquidity and capital needs in their funds and portfolios. As for traditional secondaries trades, he says more investor portfolios are coming onto the secondary market, but expects this to increase further next year, “especially as fund NAVs get adjusted and pricing ‘optics’ improve.”

What is surprising about Ares’ and Blackstone’s achievements, however, is that they point to real estate secondaries experiencing more traction in the current fundraising market than real estate debt funds. Since interest rates began rising fast, the attractive return potential afforded by debt investments became the talk of the industry. According to a report by law firm Macfarlanes, the number of real estate debt fund launches tripled from 2022 to 2023, with at least 10 of these established by managers new to the strategy.

Yet, manager ambitions for putting capital to work in debt strategies are not yet bearing fruit on the largest stage. Only one debt fund sits among the top 10 closed-end private real estate funds closed this year: PIMCO Commercial Real Estate Debt Fund II with $3 billion. As of the end of Q3, only one debt fund features among the top 10 funds in market: Blackstone’s Real Estate Debt Strategies V.

Although it will take time for more sizable debt funds to reach final close, PERE data shows Ares’ latest secondaries fund held a first close on $1.5 billion in December 2022, meaning the fund more than doubled in size over the course of 2023. Similarly, Blackstone’s held a $1 billion first close in November 2022, again more than doubling just a year later.

While both real estate debt and secondaries funds are each fulfilling a key need in today’s market, the prominence of the latter on the capital raising stage this year suggests a need for liquidity, over and above access to debt fund financing, and that is driving significant opportunities for deployment.