AMERICAS NEWS: Rise of the non-traditional buyer

In the span of about six months, NorthStar Realty Finance has gone from being a non-player in the real estate secondaries market to being one of the largest buyers. Last month, the New York-based commercial real estate investment and asset management firm teamed up with Goldman Sachs Asset Management to buy up to 25 fund interests with an approximate net asset value (NAV) of $925 million from the New Jersey Division of Investment. It was one of the largest real estate secondaries transactions to ever trade. 

Just four months prior, NorthStar closed on the partial acquisition of 45 real estate fund interests with a NAV of approximately $765 million. In that deal, it purchased a 51 percent stake in the interests from financial services organization TIAA-CREF for $390 million. 

NorthStar may be the most high-profile buyer to have entered the real estate secondaries space in recent months, but it is far from the only non-traditional newcomer. “You’re seeing all these non-traditional players coming into the market,” said Peter McGrath, founder and managing director at Setter Capital, a Toronto-based secondaries advisory firm. 

Three or four years ago, the market was dominated by a handful of secondaries-focused firms, such as Landmark Partners and Partners Group, as well as 30 to 40 non-traditional buyers that played a lesser role, according to McGrath. Over the past two to three years, however, the number of non-traditional buyers – hedge funds, pension plans, endowments and others that are interested in, but not dedicated to, buying real estate fund stakes – has ballooned to more than 200. 

Such a change in demand isn’t just a reflection of the current market cycle either. McGrath predicted the upward shift to be permanent in light of greater familiarity with the real estate secondaries market. “It’s no longer just an interesting niche,” he said. “It’s something that a lot of people have experienced firsthand,” either by bidding on, purchasing or selling fund stakes. 

NorthStar is an aberration among non-traditional buyers in that the vast majority of such parties previously have been fund investors. Known primarily as a commercial real estate lender, the firm has made a variety of equity investments in net-leased office, industrial and retail properties; healthcare properties; and other assets, such as manufactured housing communities. However, it didn’t have any exposure to funds prior to the TIAA-CREF transaction. 

For NorthStar, buying real estate fund interests is “an alternative, non-correlated way to get broad exposure to commercial real estate,” said Daniel Altscher, an equity analyst at FBR Capital Markets, an Arlington, Virginia-based investment bank that follows the firm. “The motivation is to diversify the cash earnings streams for this company.” 

The deal also allows NorthStar to capitalize on an improving commercial real estate market, Altscher noted. He estimated that the firm acquired the fund interests at approximately 72 percent of New Jersey’s cost basis, as the original value of the interests has declined since the pension plan acquired them. “There is significant embedded upside to the underlying NAV as property values rise and move up toward – and perhaps beyond – the seller’s original cost basis,” he wrote in a research note last month.

Furthermore, NorthStar is likely to do additional secondaries deals. “The fact that NorthStar has completed two of these transactions in a short period of time is very promising for them to do additional transactions,” Altscher said. Further strengthening those chances is the firm’s partnership with Goldman Sachs, which will provide NorthStar with an additional channel for accessing other potential deals. “It casts a wider net in terms of future transactions on the private equity side,” he added.

The emergence of non-traditional buyers like NorthStar means that secondaries firms will need to change the way they do business, either by bidding higher and consequently accepting lower returns or by getting more skilled at sourcing, underwriting and structuring deals. “They will have to sharpen their pencils more,” said McGrath. 

Meanwhile, NorthStar’s acquisitions should encourage more sellers to sell, as they see pricing improve and such transactions become more commonplace. “These deals are not anomalies,” said McGrath. “The real estate secondaries market is going to continue to grow. It’s just starting to really ramp up.” 

The liquid list
If you have ever wondered which real estate funds are the most liquid, then help is at hand. Setter Capital has introduced the Setter Liquidity Rating, which is a measure of the relative liquidity of fund investments. The rating is largely determined by the number and strength of potential buyers for a fund interest. Generally, a ‘good’ rating typically indicates 20 or more potential buyers that are interested in bidding on a fund interest, while ‘very good’ and ‘excellent’ represent progressively higher levels of potential demand. Here is a sample of some funds that have received ‘good’ to ‘excellent’ ratings:
Beacon Capital Strategic Partners series
Blackstone Real Estate Partners series
Carlyle Realty Partners (US series)
Gaw Capital’s Gateway Real Estate series 
LaSalle Asia Opportunity Fund series
Starwood Global Opportunity Fund series
TA Realty Associates Fund series
Tishman Speyer European Real Estate Venture series
Walton Street Real Estate Fund series
Westbrook Real Estate Fund series