Real estate secondaries on the cusp of a golden age

A broad pipeline of manager- and investor-led deals is emerging in the current liquidity-constrained market, fuelling long-term growth.

The decline in real estate secondary transaction volumes in 2023 following the record high of the previous year will most likely go down in history as a blip in its evolution. Against the backdrop of higher-for-longer interest rates and a broad correction of real estate values, both investors and managers now have a greater pent-up need to generate liquidity.

Market participants across the board say all signals point to accelerated growth in the secondaries market for private real estate fund shares over the next few years.

New York-based private markets investment and advisory firm StepStone Group is particularly upbeat and expects bull-market conditions to emerge for real estate secondaries out of the turmoil in the broader markets. Now is a strong time to be investing in secondaries, the company’s head of real estate, Jeff Giller, said in a February podcast.

“Unlike the post-GFC period, there’s not operational distress in the assets.”

However, liquidity in 2023 was, nevertheless, as low as it was during the depths of the global financial crisis in 2008-09, according to Achal Gandhi, chief investment officer, indirect real estate strategies with CBRE Investment Management. Valuations are, moreover, bottoming out.

“If you can enter close to the trough of the valuation cycle but are able to negotiate a further discounted entry basis through the secondary market due to the illiquidity of various structures and the shutdown of capital markets more broadly, then this represents to us an incredibly attractive vintage,” notes Gandhi.

Supply has never been bigger, according to data from global alternative investment manager Ares Management. The US-headquartered firm estimates there is more than $970 billion in net asset value (NAV) held in closed-end real estate funds, and that $180 billion of this is held in funds older than eight years. Outside of funds, there is more than $1 trillion of NAV held in nonfund structures such as joint ventures and separate accounts.

Mounting debt maturities within legacy vehicles, coupled with portfolios that need more time or capital to complete business plans, are now converging with lower distributions from funds and creating liquidity issues for some investors. That scenario, in combination with the denominator effect, is already triggering more sales in conventional investor-led secondaries, says Kieran Farrelly, head of global solutions, real estate at global private markets asset manager Schroders Capital.

“In the UK, there are substantial redemptions, particularly from defined benefit funds, and there is a very real opportunity to buy those interests at attractive discounts,” explains Farrelly. “More of that will permeate across Europe.”

Investor-leds comeback

During the GFC, acquiring secondaries interests was largely confined to buying investors’ interests in funds. Over time, real estate secondaries have followed private equity secondaries in not only being a much larger portion of the overall transaction market, but also expanding from investors looking to sell an interest to managers pursuing recapitalisations and meeting other liquidity needs such as for fund continuation vehicles and platform expansions. Manager-leds have dominated trading since 2020, data from global independent investment banking firm Evercore shows.

“We’re going to find a lot of structures short of what’s needed to future proof assets; there will be a very specific need around that”

Kiernan Farrelly
Schroders Capital

Investor-leds made a comeback in 2023, jumping 26 percent year-on-year compared to a 35 percent decline for manager-led transactions. Even so, Michelle Creed, partner and co-head of real estate secondaries at Ares, sees manager-led sales resuming their upward march in the years ahead.

“Over the past 12 months, we have seen an uptick in our real estate secondary pipeline, from both managers and investors. But when we look at the numbers, we continue to see the driving force in the market to be on the manager-led side,” says Creed.

Investor-led secondaries are generally opaquer than manager-leds, which also have the ability to recast the governance structure of a vehicle. The secondaries market today is, moreover, significantly larger than it was a decade ago and there are enough transactions happening for players to be comfortable with this alternative as a bona fide route, says James Jacobs, managing director at Lazard, a financial services advisory and asset management firm.

“Accessing secondary liquidity has become a standard tool in the armory of portfolio management, alongside the direct market,” notes Jacobs. “Our focus is on underlying asset quality and whether it is sustainable and fit for purpose, now and in the future. That market is huge. There are so many fantastic assets, portfolios and platforms out there that need additional capital to maximise their potential.”

In contrast to the post-GFC period, real estate secondaries trading is no longer necessarily synonymous with distress. CBRE IM focuses on stressed capital stacks, not stressed assets, Gandhi says. “In this environment, we are able to acquire positions that provide exposure to our preferred segments in stabilised high-quality assets but at a discounted basis because of those stressed capital stacks.”

NAVs to normalise

Secondaries interests in private real estate funds trade at roughly a 10 percent discount under normal conditions, but today, considerably higher haircuts are available. Data from Ares Management shows that portfolio pricing in 2023 ranged from a 15-85 percent discount to NAV, on an all-cash basis.

“Throughout most of 2023, GPs were still rightsizing NAV to reflect current value, leading to a large optical discount and large bid-ask spreads as a result,” Creed says. “As NAVs normalise, we believe the bid-ask spread will normalise.”


Year-on-year jump in investor-led transactions last year

There is also room for significant growth. Historically, 1 percent of real estate NAV has turned over in the secondaries market, while private equity secondaries has averaged approximately 2 percent. Even assuming a 1.5 percent turnover rate, annual real estate secondaries volume would be $14.25 billion. Creed foresees a further increase of at least 45 percent year-on-year from 2023 and believes that figure could even double. “The intersection between a frozen capital market and a challenging fundraising market is creating a bit of a perfect storm for real estate secondaries,” she says.

US-weighted partnerships have traditionally led in real estate secondaries trading and accounted for 62 percent of total volume in 2023, compared to 32 percent for Europe and just 6 percent for Asia. Europe could definitely make up some ground in the coming years given the need that is emerging for special situations capital, says Farrelly.

“With some $250 billion in debt rolling across major markets in Europe alone in the next four years, we estimate that there’s a funding gap of between $50 billion and upwards of $100 billion over that period,” notes Farrelly. “A secondary program can help resolve that through the recapitalisation angle. There are so many moving parts, but even at the lowest end of the range, that’s a very sizeable opportunity to address.”

One type of pressing capital need that is often overlooked is for green capex, he explains. “In a European context, I think we’re going to find a lot of structures short of what’s needed to future proof assets. There will be a very specific need around that.”

While ‘beds and sheds’ remain the flavour of the year in both the primary and secondaries markets, alongside data centres and healthcare properties, Lazard is agnostic about sector type. “We target situations across large, deep, liquid markets and in sectors that are experiencing growth or positive tailwinds, usually based on underlying favourable demographics and/or positive supply-demand imbalances,” says James. “We try not to generalise. It’s not true that there’s nothing to do in office or retail: I like office, it’s not dead. But you need to really understand the asset, the submarket and the business plan.

“The right type of office, in the right market, configured in the right way, with the right ESG credentials that’s able to attract the right tenant, can be a really good investment strategy. The same applies to retail.”

Recaps making moves

A relatively small group of large US investment firms, including Ares, Brookfield, Blackstone and StepStone, continue to dominate the global real estate secondaries market. In Europe, Partners Group stands out as a specialist player while Aquilius Investment Partners is one of the few real estate secondaries investors with dedicated capital for opportunities in the APAC region.

Both Europe and Asia are poised for growth, but US dominance is not going to change any time soon, says Farrelly.

“The more Europe-orientated, multi-manager groups will execute secondaries as part of their day-to-day activity,” he notes. “Some may or may not have a dedicated sleeve or programme for it, but ultimately, it’s part of the entire indirect opportunity set – whether that be a primary fund, co-investment or JV. It has been for many years.”

Farrelly does, nevertheless, see an opportunity for more specialist European players to enter the space. “We’re entering a vintage year or two where there’s going to be a great buying opportunity. I think a lot of that revolves around the recapitalisation opportunity, and I can see that becoming a much more permanent feature of the European market. We’re already seeing a number of broader special situations funds and value-add/opportunistic vehicles executing these, so the grey boundaries where groups bump into each other are going to be very real in today’s market.”

In a clear sign of investor appetite, two of the largest fundraises in 2023 occurred in the secondaries corner of the market. While 2023 was the worst fundraising year for private equity real estate in the past 11 years, there was a meaningful increase in the amount raised by real estate secondaries funds with the percentage committed to the strategy climbing from 0 percent in 2022 to 6 percent in 2023, affiliate title PERE data shows. Ares’ Landmark Real Estate Fund IX closed on $3.3 billion in December, following a $2.6 billion close by Blackstone’s Strategic Partners Real Estate VIII in November.

“That reflects the need and opportunity given the current market environment,” according to Jacobs. “There are nevertheless a lot more dedicated secondaries funds in the broader private equity market. In that regard, the real estate secondaries market still has a long way to go.”