FEATURE: Anecdotal evidence

With no central monitoring forum, tracking real estate secondaries transactions currently is something of an anecdotal game. Last month, PERE heard anecdotally that an “eBay-style” auction recently took place for a portfolio of secondary fund positions in Europe. While we cannot divulge details, the notion of an online bidding war for such assets underlines one strong theme: namely that bid-ask spreads between buyers and sellers are showing signs of narrowing.

All the talk in 2009 and 2010 was about discounts, but eventually it could switch to premiums. If values start to rise, people will still want liquidity but they may want liquidity at premiums to NAV because they perceive the fair value of their units is actually above the price Will Rowson, ING REIM

That considered, you’d expect to see an upswing in transactional activity. A glance at the statistics and projections of Connecticut-based private equity and real estate secondaries specialist firm Landmark Partners suggests this consideration is correct. Landmark’s research reveals total secondaries transactions increased from $500 million between 2003 and 2007 to $855 million in 2008 and $1.2 billion in 2009, the years immediately following the global financial crisis. Last year, Landmark tracked $4.5 billion of secondary units for sale, roughly $1.6 billion of which traded.

Increased trading activity has widely been attributed to distress evident across global real estate markets post-financial crisis, with investors scouring for units where sellers are motivated, or forced, to trade at discounts to net asset value (NAV). Further anecdotes shared with PERE include instances of discounts extending as far as 80 percent, although these trades were seen as exceptional, not regular.

“To some extent, the major distress was never there,” recalls Paul Parker, Landmark’s European managing director. “When the shock hit the market, basically everything was for sale. But of the $10 billion we logged as ‘for sale’ in 2008 and 2009, only about 10 percent actually traded.”

Today, talk of mega-discounts is largely over. However, a dearth of bargain bucket opportunities does not mean a reduction in transactions. Indeed, Parker expects between $2 billion and $4 billion to trade over the next two to three years, and Landmark itself aims to capture its share. Last month, the firm closed on $718 million for Landmark Real Estate Fund VI, its latest in a series of secondaries real estate funds and one of the biggest dedicated secondaries vehicle ever raised.

Swinging to premiums

With regard to secondaries in Europe, the pendulum definitely is swinging towards more utterances of trades at a premium to NAV. Will Rowson, chief investment officer of the European division of ING Real Estate Investment Management (REIM), says: “All the talk in 2009 and 2010 was about discounts, but eventually it could switch to premiums. If values start to rise, people will still want liquidity but they may want liquidity at premiums to NAV because they perceive the fair value of their units is actually above the price.”

Jeremy Plummer, managing director of CBRE Investor’s global multi-manager division, says: “They are still rare, but there is logic there. If there’s a reasonable time horizon on the fund and it has some good assets, you’re bypassing normal transaction costs.” He points to UK funds where such instances have surfaced, adding that CBRE Investors recently completed such a deal. “It was at a modest premium,” he admits, “but it looked like a good value.”

Landmark’s Parker also has seen investors “price in growth” in the UK. “There have been a few examples,” he says. “In central London, for instance, people are feeling compelled to price in growth as the market is becoming more hotly contested, so they pay a premium.”

There was one instance when we paid above NAV. We felt the GP had undervalued the portfolio, and that proved to be an extremely successful transaction Joseph Stecher, Morgan Stanley Alternative Investment Partners

Parker points out, however, that fund managers often operate using different return horizons from one another, which can lead to certain acquisitions at a premium to NAV deemed acceptable to one manager and not to another. Furthermore, he says it is important to make the distinction between the UK and Continental Europe, as funds focused on the former often are benchmarked against the Investment Property Databank (IPD) and therefore have relative not absolute return hurdles. With funds in the latter, that is not always so.

Parker does not think premium sales currently are replacing discounted sales, but he says: “Most people are taking the view that NAV reflects reality, so numbers of heavily discounted units have come down. The bid-ask spread is much narrower – pretty much around NAV now.”

Another secondaries investment firm to have completed a recent acquisition at a premium to NAV is Morgan Stanley Alternative Investment Partners (AIP), the division of Morgan Stanley responsible for its real estate secondaries fund, Phoenix Global Real Estate Secondaries fund, which closed on $370 million last March. Joseph Stecher, chief investment officer and head of the fund’s platform, recollects: “There was one instance when we paid above NAV. We felt the GP had undervalued the portfolio, and that proved to be an extremely successful transaction.”

Stecher, however, believes that secondary investors should not regard NAV as a decisive factor: “We underwrite the portfolio as if we were buying it directly. We come up with a valuation we believe in. Of course, we look at NAV and it is important to the seller, but we don’t track it.” He says factors like a fund’s liquidity, the GP’s fees and carry (which are often not taken into account in a unit’s NAV) and a general sense of “optimism” among GPs can lead to distorted valuations. “NAV is just one person’s opinion of value after all,” he points out.

Removing the stigma

Whether European secondaries increasingly will trade at premiums to NAV or remain in discount territory will likely remain subject to anecdotal evidence and conjecture until GPs and LPs can shake the perception that there is a stigma associated with openly marketing secondary units. As Landmark’s Parker highlights, despite numerous instances of perfectly logical reasons: “GPs would ask ‘What have I done wrong? Why does my LP want out?’ Meanwhile, LPs ask ‘Will I ever get to invest with this GP again?’ There’s a sense of people not wanting to break up relationships.”

They are still rare, but there is logic there. If there’s a reasonable time horizon on the fund and it has some good assets, you’re bypassing normal transaction costs Jeremy Plummer, CBRE Investors

Landmark’s transaction tracking and prediction methodology, Parker admits, comes from applying investment patterns observed in the more mature and established private equity market to its real estate intelligence. It also does not include trades between LPs, which are harder to track, often precisely because of the stigmatisation associated with such exchanges.

Some firms even reject the notion that the volume of real estate secondaries sales currently is quantifiable. Morgan Stanley’s Stecher says: “We have closed on a number of transactions, the vast majority of which were completed on a proprietary basis. We’re pretty sure our competition doesn’t know these occurred.”

With the real estate secondaries market essentially still a junior universe, questions of whether there’s a shift towards investing at a premium to NAV will remain answered somewhat anecdotally. Still, from PERE’s conversations, most would agree that there is a closer proximity between buyer and seller positions. And if more eBay-style auction stories and the like surface, it would be fair to predict more premium secondary sales will too.