Who are the sellers in real estate secondaries?

In this extract from The Secondaries Market, published in early December, James Sunday and Min Zhou of Landmark Partners offer an overview of the real estate sub-asset class and look at which organisations are selling.

The real estate secondaries market has experienced an unprecedented level of growth over the past seven years, both in terms of dollar volume and number of transactions (see Figure 12.1). In 2015, the real estate secondaries market registered its strongest year ever with $8.2 billion of closed transactions, a 70 percent increase over volume achieved in 2014.

This growth was spurred by a ramp up in activity by large public pension funds as well as an increasing desire by limited partners to rebalance legacy real estate fund portfolios. This growth has increased both the visibility and validation of the secondaries market as a portfolio management tool, which in turn is expected to continue to drive robust transaction volume.

Market overview

Secondaries transaction volume is a function of how much net asset value is currently held across the universe of real estate funds. As observed in both private equity and real estate, a small percentage of this NAV trades every year. This percentage is referred to as turnover ratio.

Landmark has tracked total outstanding NAV and annual secondaries transaction volume since 2005. Over this time, total real estate NAV across the industry has increased from approximately $100 billion in 2005 to $485 billion in 2015. Much of this growth is attributed to the significant increase in primary commitments raised by real estate funds from 2005 to 2008.

Over the past ten years, the average real estate secondaries turnover ratio has been 0.75 percent versus the 1.5 percent observed in the more mature private equity secondaries market. Post-global financial crisis, real estate secondaries turnover ratios generally have been on an upward trajectory, with growth significantly accelerating from 2012 to 2015. In 2015, real estate turnover ratios reached 16 percent, highlighting a more widespread acceptance of the secondaries market as an effective portfolio management tool (see Figure 12.2).

From 2012 to 2015, secondaries transaction volume grew approximately 47 percent per year. Landmark collected and analysed detailed transaction data during this period, which enabled it to identify major trends behind the surging transaction volume. Below is an analysis of those trends with regards to:

• types of sellers;
• secondaries buyers;
• geographic exposure of funds traded; and
• transaction size and transaction

Types of sellers           

Broad-based growth of secondaries market

The number of transactions per year has grown substantially from an average of 53 in 2012 and 2013 to an average of 92 in 2014 and 2015. This trend highlights the increasing comfort LPs have in managing their real estate fund portfolios in the secondaries market. A significant percentage of these LPs were first-time sellers, hence expanding the number of participants in the secondaries market.

Landmark groups sellers into seven major categories:

1. US pension funds
2. Non-US pension funds
3. Banks
4. Endowments/foundations
5. Insurance companies
6. Funds of funds
7. Other

Between 2012 and 2015, all major seller types enjoyed large percentage increases in the average number of transactions completed, highlighting the broad-based growth of the secondaries market. Pension funds and endowments/foundations, in particular, saw very strong growth, with a 100 percent increase in the number of completed transactions during the period. Funds of funds also experienced a very large increase, driven by the desire to create liquidity for redemption requests and/or to accelerate the wind down of very mature funds (see Figure 12.3).

US-based sellers, particularly pension funds, fuel the volume growth

In terms of transaction volume, Figure 4 shows that US pension funds were the biggest driver of dollar volume growth, accounting for 63 percent of total transaction volume in 2015, up from an average of 23 percent in the previous three years. This surge is on the heels of two large US public pension plans utilising the secondaries market to monetise a total of $4.5 billion of  NAV in 2015.

These two transactions signify the key trend that US public pension funds, which have historically been concerned about the depth of the secondaries market and thus reluctant to manage their real estate fund portfolios proactively, are becoming more active in utilising the secondaries market as a portfolio management tool. US public pension funds are fertile ground for future growth of the market, as only six US public pension funds transacted between 2012 and 2015. This leaves a significant number of US public pensions with substantial legacy portfolios that have not been rebalanced.

Endowments and foundations were the second most active seller in the marketplace, generating $1 billion of total transaction volume, up significantly from the $75 million volume in 2012 and $500 million in 2013.

Elsewhere, banks supplied fairly steady volume between 2012 and 2015, averaging around $600 million per year as they systematically worked to comply with capital regulations in jurisdictions around the world.

Looking at the origin of sellers, US-based sellers were the most active in 2015, accounting for 83 percent of transaction volume, a significant uptick from the 51 percent observed in 2012. Even when stripping out the above mentioned two large US pension fund transactions, US-based sellers still accounted for 63 percent of the volume, a healthy growth from the 2012 level. While the share of Europe-based sellers has shrunk, the overall dollar volume has held relatively constant.

Watch out for our second part of this book chapter, where Sunday and Zhou discuss buyers and the geographical spread of funds traded.