The secondary market across all alternative investments has grown significantly in recent times. Although private equity makes up by far the largest share of secondaries, transaction activity is surging in the real estate space, too, as more LPs see a viable opportunity to boost liquidity as we emerge from the pandemic, and more GPs look to recapitalize assets for strategic reasons.
According to data from manager Landmark Partners and research firm Preqin, $10.6 billion in real estate secondaries was transacted on the global market in 2021, up 24 percent from 2020, which held the previous record.
The surge in transaction volume in part reflects the large amounts of dry powder in the market, following a dearth of high-quality opportunities in which to deploy this capital amid the initial uncertainty of covid-19.
PERE data shows that real estate secondaries funds had a record year in 2020, raising $7.3 billion in anticipation of a pandemic-induced sell-off.
What followed in 2021 was a very low year for real estate secondaries fundraising, but record levels of dry powder were put to work by overall secondary market investors, according to estimates by adviser Lazard. Among respondents to Lazard’s latest secondary investor survey, 63 percent said they deployed more than 40 percent of their dry powder in 2021.
If there is one theme that best reflects the continued growth and evolution of the secondary market, it is the recent explosion in GP-led activity. According to Landmark Partners and adviser Greenhill, manager-led deals have grown by 38 percent on an annualized basis in the past five years, representing two-thirds of all real estate secondaries transactions in both 2020 and 2021.
The covid crisis has been an obvious factor in the accelerated growth of the GP-led portion of the market, given the traditional motivations for recapitalizing assets amid downturns. But to ascribe full responsibility for the GP-led boom to the pandemic would be to ignore other key trends, including that GP-led deals are no longer reserved for assets in distress or aging funds. For a growing cohort of managers, only the best assets are lined up for recapitalizing, where a GP sees an opportunity to free up or attract new capital to develop properties with high growth potential and create more value for their investors over the longer term.
Another key factor is the expanding buyer pool. “Sovereign wealth and pension funds have gotten more sophisticated and comfortable with direct and related-party transactions,” says Jarrett Vitulli, co-head of real estate capital advisory at Evercore. “We are seeing an increased desire on their part to invest through the recapitalization of existing portfolios.”
There are many reasons why more managers are choosing to transact on the secondary market, but time and liquidity are among the most pertinent factors. Many market participants are are all too familiar with the strategic reshuffling at play in many property markets, with assets being repositioned or repurposed to meet changing occupier demands and priorities, and value creation taking on new forms – engaging with net zero and reconfiguring for hybrid work among the top themes. Asset managers need fresh capital to lead such extensive developments, and they also need more time with the property.
“In most cases, the LPs that decide to ‘roll’ and stay in the fund usually also agree to a multi-year term extension in order to provide the fund sponsor with enough time to finish the business plans,” says Michelle Creed, partner at Landmark Partners, an Ares company. The secondaries market is therefore an increasingly viable tool in the property manager’s value creation arsenal.
3Best interests at heart
Amid the rise in GP-leds, how can LPs be sure they are getting a fair deal? There has been much discussion over the need to protect LPs’ interests in the GP-led transaction. Indeed, proposals published by the Securities and Exchange Commission in February aim to improve transparency for LPs by requiring GPs to file current reports within a day of closing a deal, and to obtain a fairness opinion to ensure reasonable prices.
“Price is not the only consideration, though,” says Chris Reilly, Brookfield’s head of real estate secondaries. “Fit is also important. Both parties need to live happily with each other in the new vehicle for quite some time. It is sort of like a marriage – you can definitely get it wrong.”
The strength of the relationship between a GP and its LPs has always been critical to private market success. But in the secondary market, where continuation deals are typically more complex and concentrated than other transaction types, this relationship is even more important.
In a recap scenario, participants on both sides of the table need to be able to achieve their strategic goals. “The biggest complexity is the inherent conflict of interest,” says Robert Kohn, partner at manager Park Madison Partners. “The way to resolve that is to make sure the recap is in the best interests of the existing investors, through process, transparency, communication, and creating competition around pricing.”
When GPs recapitalize a portfolio or asset with their own commitment involved, it sends out a strong, positive signal to investors. Moreover, buyers need the expertise and scale of a trusted seller to navigate a recapitalization. It works both ways: when a quality sponsor chooses to roll into the continuation fund with an even larger commitment, it sends a message to the investor community that they trust and value this relationship. Given that a key factor for GPs in the decision to sell on the secondary market is often to add new or large investors to their roster for strategic reasons, their reputation and integrity as a seller is just as important.
4LP-leds: Do not count them out
Amid all the hype around GP-led deals, you would be forgiven for assuming sales of LP interests are in decline. There is evidence, however, that this fall is only proportional to the boom in manager-led transactions. According to a report by Landmark Partners, the total value of sales of LP interests in value-added and opportunistic real estate funds rebounded in 2021 to $1.9 billion, nearly double the $1 billion recorded the previous year.
Traditional secondary sales continue to offer fund sponsors valuable liquidity, as well as the option to strategically rebalance their portfolios. That is something expected to increase further as covid’s divergent, longer-term impact on property sectors becomes clearer.
“Historically, activity in the private equity secondaries market has been an indicator of what might happen in real estate secondaries, and despite a lot of focus on GP-led deals in that space, private equity LP deals have not gone away,” explains Scott Koenig, managing director and head of real estate secondaries at manager Neuberger Berman.
5Beyond the figures
At first glance, it looks likely that real estate secondaries fundraising’s recent slowdown will continue through 2022. PERE’s annual Investor Perspectives Study over the past four years shows a clear drop-off in appetite for commitments post-2020, with the proportion of real estate investors planning to commit capital to secondaries only gradually recovering from 10 percent in 2021 to 13 percent in this year’s survey. But to what extent is this a barometer of market activity?
The industry experts featured in this report appear unanimous that secondaries transactions have a bright future in real estate. Activity will remain strong and deals will continue to get larger, particularly on the GP-led side.
If fundraising figures stay low, this would point to secondaries fund managers not needing significant capital injections at this stage, as they focus instead on deploying the mountain of dry powder obtained following record fund closures in 2020.
Just beyond one quarter into the year, several notable real estate secondaries deals have already hit the headlines.
March 2022 – Pantheon seeded a new joint venture on the back of recapitalizing a portfolio managed by ShopOne Centers REIT. The new JV creates more than $1 billion in additional capital for follow-on deals targeting grocery-anchored shopping centers in the US.
March 2022 – Brookfield Asset Management’s debut real estate secondaries fund backed a deal with Longpoint Realty Partners to recapitalize a portfolio of 31 logistics properties across the US for $700 million. Longpoint has now divested all of the properties in its first fund.
February 2022 – Blackstone agreed a €21 billion recapitalization of European last-mile logistics company Mileway, in what is the largest private real estate transaction of all time. It was reported that most LPs are to roll with the asset, with no follow-on capital included.