Q&A: Stecher’s secondaries search

Morgan Stanley Alternative Investment Partners raised $370 million for its latest secondaries vehicle – Morgan Stanley AIP Phoenix Global Real Estate Secondaries – 30 percent more than its original target. Joseph Stecher, head and chief investment officer of AIP real estate fund of funds, talks about the fundraise, the fund’s strategy and the “enduring” focus on NAVs.

Morgan Stanley Alternative Investment Partners’ has closed the first real estate secondaries fund of 2010. In raising $370 million for Morgan Stanley AIP Phoenix Global Real Estate Secondaries, the firm intends to target the growing number of limited partners looking to exit their fund interests early.

Indeed, AIP’s real estate fund of funds head and chief investment officer Joseph D. Stecher argues secondaries deal flow is so great he could invest the entire vehicle tomorrow if he wanted.

Will you invest all your money tomorrow?
No (laughing), but there is massive deal flow in relation to real estate secondary interests, especially from endowments, insurance companies and high-net-worth individuals. The high-net-worth community and endowments are good people to talk to and we’ve had pretty good success to date in sourcing and closing secondaries transactions.

What about the public pension funds? Are they proving to be willing sellers?
The larger pensions are not selling as much at present, the reason being there is just a little bit less internal pressure on them to boost their liquidity than for funds at endowments or among high-net-worths.

What’s the main strategy of the Phoenix Global fund?
We are looking to invest in vehicles globally with a fund size roughly between $400 million and $800 million. We want to invest with vertically integrated teams that operate a fairly narrow band in relation to geography and property type, but who concentrate on income-producing properties. When investing in a secondary fund interest we strongly prefer to invest in teams that have been together for a long time and are actually invested in the deals themselves. We prefer to invest with managers that we like on a primary basis, as you need your GP to do a good job over the next couple of years, because markets will continue to be challenging.

What will be your typical deal size?
Around $20 million.

Are you able to get comfortable with valuations, considering the volatility of real estate prices over the past 18 months?
We focus on small- to mid- size funds that buy a property at a time rather than a company at a time. As a result, we can perform a real estate valuation on the fund's portfolio that is entirely independent of the GP's NAV. We believe the GP’s net asset value is one person's opinion of value, and we may agree with it and we may not. So we really focus on risk adjusted returns from the underlying properties, and the variance with NAV is the result that falls out of our process. The volatility in values is due to three significant occurrences, including reduced rental income, increased required returns on equity, and the reduced availability of debt, which now costs more to obtain. We take all of that into account when we underwrite the properties in the funds that we buy. Sometimes those NAVs can be too low and sometimes they can be too high, however the focus among many sellers is still very much remains on the NAV.

Phoenix raised the majority of its money in 2009, a difficult year for any fundraising effort. How was it?
When we first started thinking about this fund in late 2008, we set a target of $250 million and a hard cap of $400 million and we really didn’t think we’d get to that cap. However, as we continued to market the fund, investors expressed more and more interest in the vehicle. We actually told our distribution team to stop selling at $350 million there was so much interest. They came in at $370 million. It was a great success.