Real estate markets in many parts of the world can be considered to be nearing cyclical zeniths. As such, many buyers within the real estate secondaries space – which traditionally involves the acquisition of LP stakes in property funds – are cautious.
“You really have to question in this point in the cycle, does it make sense to pay close to par for funds that are close to winding down?” says Marc Weiss, partner and head of the private real estate secondaries and primaries business unit at Partners Group.
The Zug, Switzerland-headquartered investment firm amassed the largest pool of dedicated capital for real estate secondaries when it closed on $1.95 billion for its Partners Group Real Estate Secondary 2013 fund, almost double the original $1 billion target, according to sister publication PERE‘s data.
“There is plenty of opportunity in the market for experienced secondaries investors, but you need to go off the beaten track to find it. I think if you look at what is being offered up by sellers in the ‘traditional’ secondaries market, probably with the exception of the portfolios of CalPERS and a handful of other similar-sized investors, the overall pool of what could be sold is getting smaller,” Weiss continues.
He adds that this is why there are not many new entrants to the market on the one hand, and why the few new players there are find it challenging to get access to investment opportunities and deploy capital on the other hand.
“If you look at the traditional space you are going to find opportunities mostly from public pension plans and probably some endowments and foundations that are trying to wean themselves off their pre-global financial crisis funds – although they tend to be acutely price sensitive. You have to think back to motivation: if the seller is not very motivated to sell, what is the point of them accepting anything that is not close to par?” says Weiss.
The opportunities of the past, such as banks and insurance companies selling down their fund exposure due to regulatory constraints, are not as readily available today: “There is still a bit they have to part with on the private equity side, but when it comes to real estate, a lot have already cleansed what they wanted to sell. I think there will be far fewer opportunities there than anywhere else.”
The story in the US and Europe is similar and the types of secondaries sellers do not vary significantly in that they are typically financial institutions, pension funds, and endowments and foundations.
Yet, the challenging macroeconomic and geopolitical situation in Europe is creating greater opportunities, says Stefan Lempen, senior vice-president, co-head private real estate secondaries at Partners. “What is helping us is the political uncertainty in the UK surrounding Brexit. It generally plays in our favor when there is a level of uncertainty of money moving into or out of a market.”
Still, an increasing part of the seller universe is being made up of property funds or funds of funds looking to lock in an IRR, Lempen adds.
Breaking with tradition
The challenge global secondaries specialists now face is whether they can shift the focus from traditional secondaries to ‘non-traditional’ secondaries. One type of non-traditional transaction is a GP-led restructuring, with much of the current market opportunity focused around more mature vehicles approaching the end of their fund life.
With GP-led transactions, the goal is not only to acquire a fund stake and become a new LP. It is also about being a long-term partner to the GP. These transactions are more complex because they involve several parties: all the LPs, the GP and at least one secondaries buyer. Historically, they were associated with GPs unable to raise money in the primary market and had a certain stigma attached to them, but not anymore.
A lot of the dealflow on the non-traditional side comes straight from the GPs, says Weiss. “They are the ones in the situations where they need to wind down these pre-crisis funds and still have a lot of assets where there remains the potential to create value with some combination of more time and/or more capital, or the opportunities come from operating partners who are under pressure to sell assets in JVs because the fund managers with whom they are partnered with want to liquidate, but the operating partners have an infinite time horizon.”
“An increasing amount of transactions in Europe consist of a counterparty that is not the investor, but the manager of the property fund trying to achieve full liquidation of the fund,” adds Lempen.
That is not to say Partners is moving completely away from the traditional space. Rather, Weiss says, the firm is just putting more emphasis on non-traditional opportunities given where the real estate markets are currently, but will keep doing traditional deals on behalf of its clients when prices are right.
“Our view is that traditional secondaries, regardless of who they are coming from and how big they are, are beta trades. You buy an LP interest in a fund and you have access to whatever information is available to you, and I would argue that our business has better access than most in the industry, but just the same it is a beta trade. You have all the same rights, but also limitations, as a limited partner and therefore if you can’t make the money on the buy-side, you’ll never be successful. For beta trades, you have to price it right – if you can’t price it right in that market environment you shouldn’t buy it,” says Weiss.
He adds that high internal rate of returns can still be made on traditional secondaries as the more mature funds in market are generating a lot of cashflow. But, he says to make good multiples that capital needs to be recycled to another mature portfolio. “Those focusing on traditional deals really have to bet on recycling capital or using quite a bit of leverage – and both of these strategies generate another layer of risk to the investor.”
Not that the move towards non-traditionals for Partners Group occurred overnight. Weiss says that since 2013, non-traditionals have become an increasing part of what Partners Group does, last year representing around 75 percent of its overall transaction volume, and he expects it to be the same this year too.
“More recently, we have seen an increase in dealflow for non-traditional secondary transactions in the US and we expect to do more on that front going forward. GPs and LPs are familiarising themselves with this concept – it is still new for many, but they see the benefit for everybody involved,” says Fabian Neuenschwander, senior vice-president, co-head private real estate secondaries at Partners Group.
For instance, back in July, PERE reported that Partners Group invested $265 million on behalf of its clients in a portfolio of seven retail, mixed-use and development property assets in the US. The investment involved the restructuring of an existing mature fund. The portfolio was part of a 2006-vintage programme managed by Madison Marquette and includes retail centers in California and North Carolina totalling around one million square feet of lettable area, and large-scale mixed-use waterfront development projects in Washington DC and Asbury Park, New Jersey. Partners Group will work with Madison Marquette to operate the assets and complete renovation and development plans.
“Giving an LP liquidity at a late point in the fund life or inviting them to participate in the potential upside from a restructuring, as well as giving a GP the chance to create further value, is also a much more interesting play for us,” says Neuenschwander.
Stay tuned for the second part of this article, on nascent Asia real estate secondaries and how deals are getting harder to make.
This article was sponsored by Partners Group, and initially appeared in PERE‘s secondaries supplement.