Discounts on secondary real estate portfolios grew larger towards the end of last year in a trend that has continued into 2012, according to Partners Group, the global private markets investments firm.
The Switzerland-based group, which has €25 billion of investments under management in private real estate, private equity, infrastructure and private debt, told PERE that discounts to net asset value had remained stable throughout 2011, although it did see them ‘improve’ at the end of the year due mainly to regulatory pressures upon sellers.
Claude Angéloz, co-head of private real estate, said banks and other financial organizations were among the notable discount sellers of real estate fund interests, with this type of seller coming under pressure from a raft of regulations such as Basel III, the Volcker rule and Solvency II. Together, those new requirements relating to capital adequacy, among other things, is forcing banks into deleveraging their balance sheets. “Not that these assets are weakening them, but the cost of holding them on a bank’s balance sheet is enormously high,” he added.
Some of the banks selling real estate fund interests made their commitments to fund managers in order to gain “proximity” to them during the credit bubble, so they could secure straight-forward lending to them, explained Angéloz. Others made fund commitments with a view to making money for their proprietary books. “It is not just fund interests but individual assets that they are selling,” added the co-head of private real estate. Indeed, Partners Group currently is looking at a $500 million-plus portfolio of foreclosed assets.
Angéloz also revealed that Partners Group, which overall has raised $1.5 billion for private real estate secondaries, has deployed close to $600 million in real estate secondary deals in 2011. It actually sourced real estate assets and portfolios in the secondary market totaling more than $19 billion.
Perhaps significantly, it seems that the trend of increasing discounts on real estate secondaries is simply mirroring private equity. Typically, Partners Group invests roughly four times as much in private equity than it does in real estate in any normal year, given that private equity as an asset class is significantly larger. Colleagues on the private equity side of the business had seen “good attractive pricing” during the whole of last year, but they also saw that pricing “improve dramatically” since the summer,” meaning bigger discounts had become available, he explained. As a result, the private equity secondaries team was far more active during the second half of 2011 than in the first half.
Angéloz’s comments came as Partners Group released its 2012 H1 Private Markets Navigator on the property market, in which the firm said assets just off the beaten track screened by the mass of core investors – namely properties in prime locations in tier two cities, or in secondary locations in tier one cities – could often be sourced at attractive valuations even where the underlying fundamentals were strong.
Specifically on secondaries, the firm said: “In the near and mid-term, structural and regulatory pressures are expected to remain among the main motivations to sell followed by portfolio management considerations, which often reflect the general flight into core and out of value-added and opportunistic investments. Furthermore, financial investors and asset allocators with limited or no experience and resources to manage portfolios that had been purchased before the crisis will likely seek to exit properties and portfolios owned in joint ventures with local operators. The continued supply/demand imbalance in the secondary space explains why buyers with strong execution skills continue to be able to obtain attractive entry valuations.”
As an example, Partners Group cited a recent secondary purchase involving a stabilised portfolio of 24 mostly West German office and retail properties. The portfolio offered conservative financing of 63 percent on a loan-to-value basis, high occupancy, long remaining lease terms and quality tenants at an entry price that represented a discount of 45 percent on total invested equity. The previous majority owner of the portfolio sought to reduce its position to avoid full consolidation under applicable accounting rules. Partners Group secured the transaction as the only secondary bidder with enough capital to reduce and dilute the position size of the previous majority investor to a level below 50 percent, as well as being able to inject substantial fresh capital to take advantage of accretive acquisitions.