A time to sell

The supply and demand gap in real estate secondaries is wider than ever, but that doesn’t necessarily mean it isn’t a good time to sell.

Late last week, the New Jersey Division of Investments announced that it was considering the sale of a massive chunk of its real estate holdings through the secondary market. The potential sale, which could include stakes in some 20 funds totaling up to $1 billion, is an indicator of how much more active pension plans have become in real estate secondaries.

Pensions accounted for 30 percent of all sellers in 2012, representing the second largest group after financial institutions, according to a report released by Partners Group this week. This is up substantially from 2009, when pension plans made up just 2 percent of sellers.

The key driver for pension plans to seek early exits through the secondary market is portfolio management. In many cases, these investors are reallocating more capital to core and selling non-core real estate interests in an effort to lower risk. Additionally, some investors have pursued large-scale liquidations because of the opportunity cost of carrying legacy assets or commitments to managers with whom they no longer want to invest.

This is indeed the case with New Jersey, whose potential offering would consist of legacy fund investments that are underperforming or redundant. The pension system intends to redeploy the proceeds in a new real estate investment strategy with revised opportunistic, core and international targets, which New Jersey has not disclosed.

The offering, however, faces certain challenges. It may exacerbate an already widening disparity between supply and demand. The ratio between deal flow and fundraising in real estate secondaries has risen sharply from 6:1 in 2010 to 44:1 in 2012, according to the Partners Group report. This has handed negotiating power to buyers, which may bid prices that certain sellers may be unwilling to accept.

The buyer pool, moreover, is fairly limited, consisting of half a dozen dedicated real estate secondaries firms, several fund of funds that also invest opportunistically in secondaries and institutional investors that may invest alongside these firms through co-investment vehicles. Additionally, the sale of New Jersey’s real estate holdings would require multiple buyers, since no single firm has raised enough capital to buy the $1 billion worth of stakes outright.

Despite this, other factors may work in New Jersey’s favor. As property valuations have improved, discounts to net asset value for non-core real estate investments have come down to a current range of 10 percent to 25 percent, according to Partners Group. This moderation in discounts has correlated with a surge in completed transactions. By comparison, discounts often exceeded 50 percent in the days following the global financial crisis. Unsurprisingly, few real estate secondaries deals closed during that period.

Moreover, in the case of New Jersey, discounts may not be necessary for all the fund stakes offered as some are likely to be portfolio redundancies that may be performing fine.

In announcing a possible sale, New Jersey is testing the waters to see what kind of bids it may receive for its real estate stakes. Still, the state likely wouldn’t even be going public if it didn’t have a reasonable amount of confidence in a strengthening market.