Aquilius and White & Case on creating win-win situations in secondaries

This article was sponsored by White & Case

The GP-led real estate secondaries market is less developed in Asia than elsewhere in the world, but it is subject to the same driving forces and is evolving rapidly as more investors and managers become involved.

Success in Asia’s diverse markets requires a presence on the ground and familiarity with multiple jurisdictions and market dynamics. Continuation funds are less frequently used in Asia than in other markets, but they provide an elegant solution for the differing needs of LPs and GPs. Bastian Wolff and Christian Keiber, founding partners of Singapore-based secondaries specialist Aquilius, and Anthony Wong, head of APAC investment funds and partner at law firm White & Case, discuss the evolution of GP-led secondaries in the region.

What is the state of play in the real estate secondaries market today?

“Capital will remain constrained… pushing the secondaries market into a new structural cycle”

Bastian Wolff
Aquilius Investment Partners

Bastian Wolff: We started the year strongly and are seeing a significant dislocation in the secondaries market that will likely persist. Investors are coming off over a decade of positive cashflows from their private market portfolios. Now for the past two years, many of them are finding themselves with more capital calls than distributions, at a time where they are hitting caps in allocations. So, there is a real need today to make active choices about which assets investors want to hold and what they want to sell, which is why they are going out to the secondary market. Capital will remain constrained for the years to come, pushing the secondaries market into a new structural cycle.

Christian Keiber: Looking at the Asia-Pacific region specifically, we are seeing investors from the West pivoting back to their home markets. In times of uncertainty, they are looking for markets they understand better and in which they feel more comfortable.

Anthony Wong: We have definitely seen this for investors in North America and Europe, but also in Asia as well. Investors are facing slower distributions and the need to rebalance or de-risk their portfolios in some cases. This is against the backdrop of many funds in Asia that are approaching the end of their life and, while there is an ability to extend the term of a fund, that may not be enough of a runway to optimize assets for exit. Given the choice, LPs are likely going to want cash rather than locking up capital for an even longer period of time.

How does the market for real estate secondaries in Asia differ from other regions?

CK: The biggest difference in Asia is how transactions come together. In North America and Europe, there is a more efficient market for secondaries transactions; they are very brokered markets with a high number of intermediaries in a much more competitive environment. That is not how transactions come together in this part of the world. I would say eight out of 10 transactions we see in Asia are on a bilateral basis. That means that as a secondaries investor you need to have a team on the ground and go out to speak to LPs, speak to GPs yourself, to understand their needs.

BW: In Asia, you cannot just sit there and wait for the broker to call you. I would add that the underwriting and execution consumes a lot of our resources and requires local expertise as well. You are dealing with different legal and tax systems here, and you have to work hard to close information gaps in a less transparent market. The calories spent per dollar invested in Asia are much higher compared to other parts of the world.

“Investors are facing slower distributions and the need to rebalance or de-risk their portfolios in some cases”

Anthony Wong
White & Case

AW: In addition, you often are dealing with a patchwork of different legal and tax considerations, depending on where the assets and the deal participants are based. Foreign ownership rules can be significant issues, and these vary quite markedly from jurisdiction to jurisdiction. Foreign exchange controls can also present interesting challenges to the way deals are done. It helps to work with advisers who understand the lay of the land.

What are the main types of GP-led secondaries solutions in the market today?

CK: First, to put that in context, GP-led transactions are a smaller part of the market here in Asia. If you look at transaction volumes in North America and Europe in recent years, you see more or less an even split between LP-led and GP-led deals. This is not because GP-led solutions are less popular here, but simply because GP-led secondaries are lesser known. As the Asian secondary market matures, you would expect this ratio to move closer to what it is in North America.

No two GP-led transactions are ever the same, but the most popular is a continuation vehicle, which is a very elegant solution for a fund which has remaining assets, but that has come to the end of its life. These assets can move into a new vehicle, offering existing LPs the option to exit or to roll over into the new fund.

There are also custom-tailored solutions, such as single asset or multi-asset recapitalizations; preferred equity injections, which can be used to meet a fund’s cash requirements when LPs are unable to do so; and GP spin-outs, where you take assets off a corporate balance sheet and recapitalize them into a new vehicle while bringing along the team that managed them to create a new GP. You cannot say one or another of these options might be best in every case, because it is dependent on the individual situation.

What are the challenges of undertaking continuation funds in Asia?

“In times of uncertainty, [investors] are looking for markets they understand better and in which they feel more comfortable”

Christian Keiber
Aquilius Investment Partners

CK: For GP-led transactions in general, and specifically continuation funds, counterparties in Asia are much less familiar with the product. So, this typically involves an education process to explain how they work, what they do, when they can best be used and what the advantages and disadvantages are. This means the lead times are longer in this market; in North America it might be only six months, but it could be up to 12 months or longer in Asia. Price discovery is the other big challenge. You need a very transparent, clear process that ensures that both the old and new LPs are treated fairly and provided with the full picture.

AW: On the regulatory side, you face the same challenges of different jurisdictions, different underlying asset classes and different currencies. In some cases, we will look at bespoke structures to deal with these issues. There is far less standardization across markets here.

BW: There is also a need for underwriting experience and resources very similar to a direct transaction. One of the other complexities is that you are running very extensive due diligence on the assets while developing a partnering relationship with the GP.

Why should investors and managers consider continuation funds?

BW: A continuation fund can be a win-win for all parties involved. There is the option to accelerate liquidity for investors, or the chance to roll it over into a new structure. This means you are bridging the divergent needs of the investor base and there is real merit to that. The GP receives additional time and capital to optimize assets and to be rewarded for performance, while the secondaries investors are gaining the opportunity to access mature assets or portfolios, with potentially better terms. That is why these GP-led deals are going to be more relevant in the coming years, because they enable all parties to navigate a difficult market.

Will this strong run for secondaries transactions die down once the market has settled, or is it expected to continue?

BW: I think we are still in a very undercapitalized market when it comes to secondaries, and specifically for GP-led transactions. There is still huge potential and demand for capital. One thing we see is a need for diversification, which means we will see more syndicates, where multiple secondaries buyers are coming together. There is still room for more players and more capital in this part of the market.

CK: As more continuation funds and other GP-led secondaries deals are completed in this region, we will see a positive feedback loop, just as we have seen in Europe and the US over the past few years. It is a further evolution of the real estate secondaries market in Asia, and we expect it to expand quite dramatically over time.

Christian Keiber and Bastian Wolff are founding partners at Aquilius Investment Partners, and Anthony Wong is head of APAC investment funds and partner at law firm White & Case.