Tough time for take-off

The real estate secondaries field has not seen a new entrant into the space for quite some time. So it was noteworthy when private equity firm Neuberger Berman announced its intentions to join the game this week.

The New York-based firm is already known as a successful private equity secondaries investor; it ranked 11th among the top fundraisers in the strategy, according to Secondaries Investor’s Si30, having raised $4 billion from 2011 through 2016. It closed its fourth fund on its $2.5 billion hard-cap in January, and while specific internal rate of return figures were not available, 2016 investor documents showed the firm’s first two funds were in the top quartile when compared with other secondaries funds and traditional private equity funds.

Despite a good run in private equity secondaries, Neuberger faces a difficult road as it begins establishing a real estate footprint. The firm’s move has been greeted with scepticism at best and pessimism at worst by observers with whom sister publication PERE spoke this week, and with good reason. By many accounts, including data and anecdotal evidence on market trajectory, the timing is less than ideal for a new real estate secondaries player to be making its debut.

From a dealflow perspective, the outlook in the space is mixed. Investment activity has been on the rise over the past five years, according to Partners Group, with the firm screening $26 billion of real estate secondaries transaction volume globally in the first half of the year. This marks a rise from $19 billion in H1 2016, $19.6 billion in H1 2015 – the high-water-mark year for the industry – $14.8 billion in H1 2014 and $11 billion in H1 2013.

Nonetheless, industry observers are not optimistic about opportunities in real estate secondaries, either for needle-moving $1 billion-plus transactions or for Neuberger’s preferred strategy of single-fund transactions. For one thing, would-be buyers have fewer opportunities to purchase fund interests at a discount, given currently high valuations in real estate. Also, most real estate fund stakes coming to the secondaries market are pre-global financial crisis vehicles that have up to two years left in their lifecycle, holding periods that are not long enough to realise a significant multiple, according to one real estate secondaries investor. In fact, the lack of traditional investor-led sales of fund stakes and portfolios has led industry players to seek opportunities in the form of manager-led secondaries sales and other non-traditional secondaries plays.

Some fund investors, moreover, are not motivated to sell in the secondaries space at present. One sovereign wealth fund executive told PERE he explored the option of selling some legacy positions, but abandoned the idea because of the discounts expected by secondaries buyers. One bright spot for Neuberger, and the market in general, is the continued use of the secondaries market for portfolio management, but that is still an emerging strategy within real estate, so it is unclear whether it can form the basis of a global business at the current time.

Meanwhile, the fundraising outlook in real estate secondaries looks even less rosy. Demand for real estate secondaries funds certainly exists – with Partners Group and Landmark Partners having raised $1 billion-plus funds in recent years. However, PERE data showed fundraising for the strategy has been on the decline or plateauing: in the first half of 2017 it came to $388 million, compared with $550 million in 2016 and $2.1 billion in 2015 over the same periods.

In launching its new business, Neuberger can count among its advantages new hire Scott Koenig – who will be leading the platform after serving in a similar role with Deutsche Bank – as well as its track record in the private equity space, which can help to bolster both its capital raising and deployment efforts.

But such advantages can only serve as a partial counterbalance to the headwinds that real estate secondaries investors currently are facing. If established players are being compelled to rethink their own strategies, then it will be even tougher for a new entrant to gain solid footing.