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RE funds help prime secondary market to break records

Secondaries deal volume hit historic levels last year and is widely expected to keep the pace in 2011, thanks in part to the strong performance of real estate-related funds.


Real estate funds will become more a part of the transaction activity on the secondary market as financial institutions sell off real estate-related funds, according to David de Weese, partner with Paul Capital.

“There is a lot of real estate held by banks, both direct and fund interests, and that will be selling over the coming years,” said de Weese, who spoke to Private Equity International. Only a few managers in the market look for real estate secondary opportunities right now, he said.

Indeed, two secondary market reports have recently revealed that the secondary market was busier than ever last year, with deal volume breaking records, but activity is expected to spike even higher this year as public pensions shrink portfolios and banks pressured by regulations sell private equity assets. The reports issued this week from private equity intermediary NYPPEX and broker Cogent Partners reveal the intense, historic levels of activity last year. 

NYPPEX said total deal volume in 2011 stood at a record $27.5 billion, up 24 percent from $22 billion in 2010. Cogent pegs total deal volume at about $25 billion last year, “marking one of the busiest periods in secondary market history”, the firm said in a release.

“While most public pensions initiated transactions to achieve portfolio rebalancing objectives, financial institutions in North America, Europe and Asia divested large and diverse portfolios in response to mounting regulatory pressures,” said Brian Mooney, managing director with Cogent.

“We expect Dodd-Frank, Basel III and Solvency II will continue to drive considerable near-term transaction activity by banks and insurance companies,” he said.

The roughly $35 billion deal total estimate for this year is “based primarily on our observations of large deal pipelines at prospective secondary buyers and sellers”, NYYPEX said in a statement. 

Pricing fluctuated last year, as median bid prices increased to 69.4 percent of NAV as of 31 December from 68.9 percent as of 31 December, 2010. High bids, however, decreased about 7.9 percent from 92.4 percent in December 2010 to 85.13 last year, according to NYPPEX.

The average high first round bid for all funds dropped to 80.6 percent of NAV in the second half of last year, compared to 84.5 percent in the first half, Cogent said. The decline “was driven primarily by macroeconomic concerns stemming from the Eurozone debt crisis and public stock market volatility”, Cogent said in the report.

The best performing bid prices last year were for natural resources and real estate funds due to expectations about inflation rates and buyers’ preferences for cash flow, NYPPEX said. The worst performing funds in terms of bid prices were hedge and venture funds due to underperformance and uncertainty of exit, the firm said. 

Interestingly, NYPPEX also found that LPs were trying to manage currency risk through the secondary market by swapping out of funds of certain currency denominations into other currencies.

“Some US investors sought to reduce Euro-denominated buyout funds by swapping into comparable US dollar denominated buyout funds,” the firm said. A panel of LPs confirmed this currency concern at a recent industry conference, saying that LPs have gone so far as to request Euro-based fund managers carve out parallel, US dollar-denominated vehicles for their commitments.

“There’s not a lot of capital on the buy side in that area,” de Weese added. “It’s an interesting area and will continue to be over the next few years.”