Greenhill’s Bill Thompson, co-head of capital advisory, and Andy Nick, a managing director at Greenhill Cogent, recount how private real estate secondaries has matured from being one-dimensional and liquidity-driven to an increasingly accepted portfolio management and restructuring tool.
Let’s start at the beginning. Talk us through the first private real estate secondaries trades.
Andy Nick: Pre-global financial crisis, the real estate sales that we saw were primarily driven by sellers needing liquidity. It was less about specific funds, more about generating cash. But we saw quite the shift during the crisis as limited partners got their heads around issues, mainly relating to global opportunistic funds as those were the most impacted by falling property values. Some had leverage facilities that meant, at that time, there was no equity in them at all. We saw a number of sellers rush for the exit, but, to be frank, there wasn’t much of a market because buyers saw the same issues with these funds. It was not until 2011 when we really saw volume build. That year, about $2 billion traded. It was a time when people could start to pare down their pre-crisis exposure to opportunity funds.
Bill Thompson: Of course, by that time the private equity secondary space had been around and growing for quite some time. In 2011, the overall secondaries market, including predominately private equity and a small amount of real estate, was probably around $22 billion in size.
Andy Nick: We didn’t even break real estate out as a standalone category in our market data during the global financial crisis, because it was such a de minimis amount. But given our position advising on private equity secondaries, we were in a pretty unique spot as people approached us to sort out their real estate allocation in a similar way post-crisis. From a standing point on the heels of the crisis, after property values, and therefore fund NAVs, had been written down, we started to see some real estate volume transact.
In the early stages, private real estate secondaries was predominantly about LP to LP trading in opportunistic funds, but the market has evolved significantly since then to include other types of trades as well. Has that made volume harder to assess?
AN: Sentiment has indeed shifted post-crisis and is comprised of much more than only opportunistic funds.
BT: Traditional secondaries in real estate focused on higher risk and return strategies and was related to closed-ended funds as opposed to the bigger, open-ended funds that had built-in liquidity mechanisms.
AN: And today, I think, from a volume perspective, the lion’s share still is from the closed-ended funds which are value-added and opportunistic in nature, although we have had conversations with folks about selling out of certain open-ended funds as well.
BT: But I think that’s the interesting thing. People are now viewing secondaries as more than just a liquidity mechanism. Today people use secondaries as much more of a portfolio management tool, which is what the private equity guys were doing a while ago. In real estate, it used to be if you were doing a secondary trade, it was a black mark, or related to an asset or fund not performing well. But that is not the case today. It is totally different now.
But the stigma has not been completely removed otherwise this marketplace would be more transparent in nature surely?
AN: I think it depends on who you talk to. Certainly, the private equity market is more established in both volume and its perception. We still talk to real estate GPs that haven’t had a secondary trade yet and we end up working on their first as part of the process we are running for an LP. So you do occasionally still find an outlier view that a sale is something negative for the GP or the LP selling. But I posit that the vast majority of market participants feel we’ve turned the corner on the point of a secondary being a stigma.
PERE: In the case of fund restructurings, the GP can sometimes even be the instigator of a secondaries trade.
BT: Yes, in certain situations, GPs are initiating dialogue regarding secondaries to solve issues related to older funds or to introduce new investors and that is a whole different ball game than traditional LP to LP secondaries.
AN: Certainly in the restructurings we’ve gotten involved with there is a business plan that still needs to be executed on and so holding the assets for another, say three years, makes a lot more sense than selling today. Those are often the ones that come to market and are likely to get done, as there is a logical reason for the transaction to take place. You may have certain LPs that want or need liquidity sooner.
As the market has evolved, transactions have become more LP-friendly. The first private equity restructurings didn’t leave the LPs with many choices. But what we’re seeing today is that investors are given more options. Those wanting to stay in a vehicle are able to do so on the same economics – no penalty for extending. They are being given a form of tender offer or a free option to take liquidity if they so desire.
BT: In some cases these days, you might have a manager that is seven or eight years into a fund. The investors are generally happy but some might want to go in a different direction or want liquidity. They’d be happy to get out at this stage of the game without forcing sales. In these scenarios, the GP can now swap an old LP for a new LP. That meets the needs of both the existing LPs that want to stay in and of the new and attractive capital provider, which is good for the GP from an operational perspective. It is the new normal.
Should we imagine then that increasing amounts of your advisory work relates to this type of secondaries trading?
AN: I would say these types of transactions are probably 20 to 30 percent of total volume, market wide. For us, because historically we’ve had a leadership position in traditional LP to LP trades, it has been closer to 10 to 15 percent of our volume. But I think, going forward, it’ll be a higher proportion, maybe even as much as a third of our revenue for 2017. As Bill says, these transactions will be the new normal.
In what other ways has the private real estate secondaries sector evolved?
AN: Another thing we’ve seen happening in private equity for some time is LPs wanting co-investments. And so we’ve sold many direct interests in companies alongside investment funds. We haven’t done as much of that on the real estate side but I think that’s because the primary side in the real estate co-investment market is more nascent. We’ll probably see greater volume in a few years.
Beyond the tender offers we discussed, I think you will also start to see more full wind-downs of funds via secondary processes. Let’s say there is a manager with a fund that is 12 years old but still has five properties left. Perhaps the manager is no longer raising funds and there have been team departures. Instead of selling properties individually using local brokers or selling to traditional real estate investors, a wind-down via a secondary sale becomes more viable and is much quicker to execute.
BT: I co-head our capital advisory business which includes a secondaries business alongside a primaries business. Although I’ve been spending 90 percent of my time on the primary side, Andy and I have interacted a lot of late as secondaries has spilled over from where they were to where they are now. Boundaries have been stretched and in some cases, broken. And I think that trend will certainly continue.
Greenhill’s capital advisory group includes two complementary businesses, Real Assets Capital Advisory and Greenhill Cogent, involving over 60 professionals in 10 markets worldwide. RACA raises capital for real asset sponsors and has been involved in 45 fundraisings totaling approximately $20 billion since 2010 at Greenhill and an additional $42 billion in a predecessor business. Greenhill Cogent offers advisory services focused on the secondary market for alternative assets, including working with leading institutional investors on utilising the secondary market to actively manage their private equity and real estate fund portfolios. Greenhill Cogent has advised over 80 investors on the sale of over $24 billion in real estate fund commitments and also works closely with managers seeking to generate liquidity for investors and/or to restructure or recapitalise funds.
This piece was sponsored by Greenhill Cogent and first appeared in sister publication PERE‘s Secondaries supplement in December 2016.