The cyclical tailwind of rising interest rates has been a catalyst for the increase in real estate secondaries transactions, but other factors internal to the asset class are also powering secular growth. These structural factors are expanding and evolving the secondaries market in ways that will drive long-term growth and transform the broader real estate market – even when interest rates eventually start to fall.
Increasingly, GPs have become more savvy about using the secondaries market to maintain control of their best assets through recapitalisations. GP-led transactions have driven significant increases in annual transaction volume over the past five years, which was previously dominated by LP transactions.
Reflecting this shift over the past decade, CBRE Investment Management (CBRE IM) uses a purposefully broad definition for secondaries that includes any transaction where equity is exchanged in the capital stack, but the operator or sponsor stays in place and maintains control over the real estate.
Classifying more types of transactions as secondaries offers a more realistic picture of the breadth and depth of the real estate secondaries market. Accurately estimating the market’s size, however, is challenging since there is no comprehensive data set and many transactions are off market. While some sources estimate annual global transaction volume at $10 billion-$15 billion, we think the market is two to three times that size, considering the volume of recapitalisations that are not captured.
The market transaction volume range could increase if the path is like private equity, where secondaries market activity increased with the growth of the primary market and now has a turnover rate of about 2-3 percent of global private equity assets under management. Real estate secondaries transaction volume – which we estimate at 1-2 percent of the market – could realistically grow to 2-3 percent of the $1,026 billion in unrealised value in private real estate funds and the more than $816 billion in non-fund structures, according to the National Council of Real Estate Investment Fiduciaries, as of March 2024.
Access to high-quality assets
The secondaries market is not just expanding, it’s also changing the entire real estate market. In addition to being used for liquidity, portfolio management and risk management, secondaries are becoming an important way to access high-quality assets. As GPs realise they can continue to create value in some of their best assets by holding onto them and recapitalising, investors cannot ignore the secondaries markets when looking for opportunities in their preferred sectors. In fact, some prime assets may never trade in the primary market again.
This evolution in the real estate secondaries market coincides with the highest interest rates in a decade across many regions. CBRE IM forecasts suggest that although interest rates may have peaked, they may not come down as quickly as they rose or return to near-zero levels – a supportive backdrop for the secondaries market. Given more reasons for investing in secondaries and greater acceptance, secondaries transactions may be less impacted by falling interest rates than in previous cycles.
At present, the fall-off in transaction volume has limited price discovery resulting in private real estate valuations still adjusting downward to reflect the current high interest rate. At this point in the cycle, only the higher-quality assets in more liquid markets, such as logistics, storage and residential, will transact – and typically at meaningful discounts. In this environment, underwriting is more challenging, benefiting experienced operators that can access preferred assets.
Valuations are likely to further support real estate secondaries. As the real estate market bottoms, close to the peak of interest rates, secondaries investments look increasingly attractive. Current discounts on prime investments enable secondaries investors to get today’s real estate at tomorrow’s prices. Historically, secondaries vintages have produced strong returns when valuations are approaching a trough.
However, investing in secondaries around an inflection point requires two competitive advantages: access to high-quality assets through strong relationships with experienced operators in local markets, and a deep understanding of the fundamentals and complex nuances of the real estate market. Investors need to be able to evaluate the price discount to real intrinsic value – not just the current valuation. Investors also need to ensure that the transaction aligns with their strategy, determine an eventual exit strategy and in some cases, take advantage of the ability to recast the governance. Opportunities often have a short execution window, requiring a local team that can mobilise quickly.
The secondaries market is increasingly providing access to some of the highest-quality assets in the broader real estate market at discounted prices with less risk. Investors will want to pay careful attention to this growing area of the market at all points in the cycle.
Kilian Toms is managing director, real estate partners strategy, at CBRE Investment Management
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