This article is sponsored by Evercore
Jarrett Vitulli has been advising on GP-led secondaries since 2005, so has had a better opportunity than most to observe how the market has evolved. “The early days of GP-led secondaries primarily involved cases where LPs had a concern about the viability of the platform. These were solutions for troubled situations,” he says.
However, over the past five years, the most sophisticated GPs have increasingly utilized the technique for strategic reasons, particularly for providing optional liquidity for limited partners. “It is an alternative to a traditional sale and enables them to identify assets from their portfolio that have long-term growth potential, then spin them out into a new special purpose entity, recapitalized in some proportion by new investors, while the current manager remains in place.”
Vitulli tells PERE why more GPs are motivated to transact on the secondary market, and how LPs can be sure they are getting fair value.
Why has the GP-led approach become more widespread in recent years?
First, the framework for these transactions has become more standardized, and as that happens to any market convention, it tends to beget more liquidity. That’s no different than what you’ve seen happen in the futures or options markets, for example.
Secondly, there has been a huge increase in the volume of capital interested in doing these types of investments. In the non-real estate private equity sector, secondaries funds have raised large amounts of capital, with some groups approaching $20 billion in size. GP-led secondaries are a way of growing the market overall.
Meanwhile, secondaries funds have also grown bigger within real estate, albeit in the context of a comparatively smaller market. There are eight to 10 groups that manage real estate secondaries funds that are north of $1 billion, so there is a very large and sophisticated buyer cohort seeking this kind of transaction.
In addition, sovereign wealth and pension funds have got more sophisticated and comfortable with direct and related-party transactions, and we are seeing an increased desire on their part to invest through the recapitalization of existing portfolios. That has created another buyer pool, and now we have to layer in the growth of non-traded REITs, which are raising an increasingly large amount of capital on a monthly basis. Five years ago, a client that had aggregated a large student housing portfolio may have sold it to a publicly traded REIT. But now, if the GP does not want to do that, there is demand from institutional investors to own those assets while the manager or operator remains in place.
And, thirdly, while GPs have recognized the opportunity, so have LPs, as it has enabled LPs to make individualized decisions with respect to specific investments and to better tailor their own exposure in the context of a sale or monetization.
What is motivating GPs to make wider use of this technique?
These deals can be very strategic: GPs can execute an alternative to a traditional sale while recasting the assets into a new vehicle specifically aligned in terms of duration and economics to maximize value.
At the end of last year, we executed a $900 million continuation fund in Europe for Optimum Asset Management, a GP that had aggregated an office and residential portfolio in Berlin. Blackstone was the winning buyer. That was an example of a large portfolio in which the manager felt there was still opportunity for long-term value creation. The transaction created an opportunity for the underlying investors to self-select a monetization or reinvestment option.
In some situations, having the GP or operator maintain continuity of ownership may be better for creating long-term value than having someone new step in. For example, in the medical office sector, investors want the benefit of established relationships with hospital systems and specialty practitioners, and you can only get that from an operator that has already created scale.
Sometimes, instead of doing a continuation fund, where the assets are transferred from one closed-end fund to another while the private equity sponsor remains in place, we work one layer down with the operator of the assets to recapitalize the portfolio by replacing one GP with another.
For instance, we are working on a large transaction where a private equity sponsor made the investment out of a fund with an opportunistic or value-add return profile. It has aggregated the portfolio and made improvements, and now we are advising on the sale of the assets from one venture into another with the operator remaining in place, but with higher cost capital being replaced with income-focused capital. Meanwhile, the operator maintains continuity of the assets.
How can existing LPs within a fund be sure they are getting fair value in GP-led deals?
The key difference with a GP-led transaction is best value versus fair value. In a traditional sale process, you engage with all the parties with the wherewithal to buy a portfolio, and you can say to existing investors that it is the best value you have been able to generate. If you are running a GP-led process, you may be excluding other peer-direct buyers, so you cannot say it is the best price, but you can say you have generated a fair value through a competitively run process.
However, if the LP does not like that value, they are typically provided with a reinvestment or rollover option to retain their exposure. It varies deal by deal, but we find that around 60 percent to 80 percent of existing LPs choose to sell. Some have their own portfolio management considerations; some see it as an opportunity to lock in a realized gain and show strong performance. Sometimes it is a matter of value-add capital exiting, while more income-focused capital buys into the new vehicle.
Moreover, we have advised on 166 GP-led transactions since 2015 and our experience is that, at times, GP-led transactions can help maximize value and this particularly true in the non-traditional property sectors. Sectors like senior housing, medical office and manufactured housing have more of an operational component. Additionally, some of these sectors have a smaller average asset size, so for investors of scale, it can take a long time to achieve a stabilized portfolio of size.
If a manager has taken the time to assemble a portfolio, there is tremendous value in being able to invest at scale on day one, which can sometimes generate a premium.
How will proposed US SEC regulation impact the market?
In the long term, regulation will actually be positive. Over the past couple of years, the Institutional Limited Partners Association has focused on GP-led deals, and has published its best practices relating to how the process should be run, the reinvestment options that should be given to existing LPs and the importance of getting a fairness opinion on the price from an independent adviser. Those are all good things for investors, and many are already happening in most, if not all, transactions. The probable next step is for the SEC to rule that this is what needs to happen in all situations.
As an adviser, what are the key considerations in structuring GP-led deals?
Each transaction must be specific in what it aims to accomplish with the real estate portfolio to match the opportunity with the most efficient form of capital. Advisers need to work closely with the GP and understand the issues that the current LPs care about. They also have to create a transaction that works for the new investors, who sometimes think about this kind of deal in a way that is very different to a direct investor. A big part is to ensure full disclosure of relevant data to all parties, so that the LPs get the benefit of all the information.
You can only know how to market a transaction like this, and what the touchpoints are for GPs and LPs, through repetition and experience. We had the benefit of being early to this business, and applied our private equity experience through a funnel that is very specific and tailored to the nuances of real estate. Private equity tends to be a year or two ahead of real estate – 2021 and 2022 were banner years for private equity in terms of the number of GP-led deals and their adoption by the GP community. We are just on the cusp of that in real estate.
Recapitalizing to capture long-term growth
Blackstone and Optimum form a joint venture to invest in German real estate
In December last year, Evercore worked with Optimum Asset Management to structure a joint venture with Blackstone to invest in a portfolio of 30 assets in Germany, valued at about €800 million. The deal provided liquidity for investors by allowing them to exit the fund, with Blackstone’s real estate arm as replacement investor, or to stay in the fund to remain invested in the growing German real estate market. Optimum has offices in Berlin and Hamburg and manages $1.8 billion in assets.
“We went to market with the goal of maximizing price for our client and offering a liquidity solution to their investors,” says Evercore’s Vitulli. “Ultimately, the best execution came in the form of a recapitalization into a joint venture backed by Blackstone, which provided our client the ability to continue managing the high-quality German portfolio they had built over time, and offered their investors the option to continue investing with Optimum or exit in full.”