When it comes to real estate secondary transactions, the focus is invariably on whether or not the assets trade at a discount to their net asset value. But the importance of such a discount is often overblown, speakers at the PERE Global Investor Forum in Los Angeles said last week.
Sarah Schwarzschild, a principal at Metropolitan Real Estate, observed that “there is significant focus” on discounts in the real estate secondary market. “There seems to be a prevalent conception that a discount is representative of the underlying return,” she said, speaking during a panel on the real estate secondaries market. In other words, a large discount is commonly perceived as a good deal for a buyer, while the situation would be the reverse for a small discount.
However, “in reality, you could do a deal today that’s done at par, and make an attractive return for your investors,” said Schwarzschild, who is responsible for her firm’s real estate secondary efforts. On the flipside, “you could have done a deal during the financial crisis at a 40 percent discount and lost money for your investors”.
Instead, she urged investors to focus on the underlying value of the assets, which could be determined through underwriting at the property level. Additionally, the reference date – the point in time at which an asset is priced for sale on the real estate secondary market – typically lags by several months. This consequently can make a discount or premium less relevant, since the market value of the assets may have changed in the intervening time period and the reference date net asset value can be stale.
Meanwhile, another panelist, Philip Barker, senior managing director at CBRE Capital Advisors, noted that premiums of single-digit percentages were being paid for certain open-ended funds, given the elevated level of interest in such vehicles. However, he explained that paying above NAV could make sense with certain fund interests. Pension funds and other institutional investors that are seeking to increase their exposure in the core space often face queues of 12 to 18 months to get into some open-ended funds, he noted.
“Presently investors are willing to commit capital to a core fund queue for an unknown date in the future and more importantly at an unknown price,” he said. “I can’t quite fathom why that would necessarily be, because you have no understanding of what the NAV might be between now and then.”
By contrast, an investor could buy an interest in the same fund right now through the secondaries market at a known NAV price, said Barker. Any premium paid should be mitigated by the benefit of immediate participation in the fund’s income return and capital appreciation.
Another buyer that is open to buying assets at a premium on the real estate secondary market is Partners Group. In fact, the firm currently is considering an investment that would involve paying an approximately 15 percent premium to net asset value. “Why would we even consider something like that? Because we believe that the NAV is grossly understated, and that the true trading value of this is probably about 35 percent above NAV,” explained Marc Weiss, head of private real estate secondaries and primaries at Partners Group. “For us, seeing the growth potential in that portfolio, it just made sense.”
By contrast, Partners Group has bid to purchase assets at a five to ten percent discount to NAV, but after doing due diligence on the transaction, realized that the assets would actually need to be acquired at closer to a 20 percent discount in order to meet the real return hurdles of the firm’s clients. “But in many cases like that, we just know that the seller is just not going to accept it, and that’s fine, we’ll walk away and do something else,” he said.
Then there is the trading of assets on the real estate secondary market at what is called par. Typically such transactions have a structure associated with them, most commonly a simple deferred payment plan where the seller agrees to pay a certain percentage of the purchase price at close and the remainder at an agreed-upon time in the future.
What that helps do is bridge a bid-ask spread, because the seller is able to have a lower headline discount,” Schwarzschild explained. “From the buyer’s side, it allows the buyer not to have to call capital from their underlying investors or use their capital partially until that point in time, so it can be accretive to returns.” Structure, which is now being used in the many of the transactions in the value-add or opportunistic space, can create a win-win for both parties and helps to get deals done, she said.