Real estate investors warming to secondary market

The secondary market for real estate investments, which grew 30% in 2014 after years of being nearly dormant, is poised to grow 45% this year to up to $7 billion, observers say.

With several $1 billion or larger portfolios of limited partnership interests in real estate funds for sale — including CalPERS' plans to sell up to $3 billion of its real estate portfolio — the market appears ready for prime time.

Based on completed transactions, the market grew 30% to $4.8 billion in 2014 from the prior year. That compares with $2 billion in completed deals in 2011, according to data from Landmark Partners, an alternative investments manager that specializes in investments on the secondary market. Landmark predicts “record growth” in 2015, to the $6 billion to $7 billion range.

“Large institutional investors have recently become increasingly more comfortable in utilizing the real estate secondary market as a portfolio management tool,” said Jamie Sunday, partner in the real estate group in Landmark's Boston office.

During the past five years, there were about three secondary real estate transactions of $400 million or more, he said. So far this year, there have been six transactions in that range, of which several were larger than $1 billion, Mr. Sunday said.

The growth of the real estate secondary market helped entice CalPERS to put a portion of its portfolio on the market, spokesman Joe D'Anda said in an e-mail. “We believe conditions are favorable and we are testing the market,” Mr. D'Anda said. “So yes, it (the growth of the real estate secondary market) does play in to the timing of this sale.”

Respondents to a recent survey by Toronto-based secondary market broker Setter Capital predicted the real estate secondary market could reach $7.7 billion in 2015. Setter conducted the survey of the most active buyers in the secondary market for alternative investment funds in January.

While there are only a handful of buyers, they have or are raising substantial amounts. That interest, coupled with the fact that there are a limited number of large portfolios for sale, has pushed prices up. And rising prices are inducing other asset owners to return to the market.

In addition to the $304.5 billion California Public Employees' Retirement System, Harvard Management Co, which oversees the Cambridge, Mass.-based university's $36.4 billion endowment, has brought a $1 billion portfolio to market, industry insiders say.

Emily Guadagnoli, spokeswoman for Harvard Management Co., in an e-mail declined comment “as a matter of policy.”

“There's been so much capital formed for real estate secondaries, (managers) have been bidding prices up to very, very strong or aggressive levels,” said Jeff Giller, San Francisco-based partner and head of StepStone Real Estate, the real estate arm of consultant and money manager StepStone Group LLC.

In May, Landmark Partners closed its latest real estate secondary market fund, Landmark Real Estate Fund VII, at $1.6 billion, exceeding its $1 billion target and the $718 million raised by its prior fund in 2010. Landmark is not alone. Morgan Stanley Alternative Investment Partners raised a $500 million fund this year.

The combined $2.1 billion raised as of July 1 is closing in on the $2.3 billion of total capital raised by three funds in all of 2014, according to London-based alternative investments research firm Preqin. Those three funds are managed by Partners Group, Aberdeen Asset Management PLC and Obligo Investment Management.

“Some of the smart (limited partners) are now in the market ... It's a seller's market with all the competition,” Mr. Giller said.

That's a big change for the secondary market for real estate investments. For years, secondary managers spoke of the promise of the secondary market for limited partnership interests in real estate as well as the market's potential to aid rebalancing and provide liquidity. But the market floundered, as there were few investors willing to sell portfolios at a substantial discount, especially after the financial crisis.

Several of the small number of managers investing on the real estate secondary market ended up either closing or being swallowed up by larger firms, which continued the business.

In 2014, StepStone bought San Francisco-based real estate secondary market firm Clairvue Capital Partners. A year earlier, Carlyle Group LP acquired Metropolitan Real Estate Equity Management LLC and The Blackstone Group LP acquired Credit Suisse Group's secondary market real estate business. These firms have been joined by new entrants including Goldman Sachs Asset Management and North Star Real Estate Group.

“One reason we integrated with StepStone is we thought a large global platform would best serve our business and investors,” said Mr. Giller, Clairvue's founder. “First, it provides better access to investment opportunities. StepStone invests in hundreds of funds and has thousands of investors and each one is a potential source of a secondary transaction. Being in the fund gives you a front-row seat to explore secondary, direct and co-investment opportunities.”

Many of these managers are raising additional capital for the real estate secondary market. For example, Blackstone Group has targeted $1 billion for its new real estate secondary market fund. LGT Capital Partners' real estate subsidiary, LGT Clerestory LLC, and Carlyle Group also are raising new real estate secondary market funds. LGT Clerestory is raising three funds, each with approximately $400 million targets, according to document filed with the Securities and Exchange Commission. The target for the Carlyle fund could not be learned.

These firms are aiming to serve the asset owners that increasingly are bringing their portfolios to the secondary market, Mr. Giller said.

Along with the attractive pricing, investors are starting to gain “a familiarity with the secondary market as a tool to manage portfolios that didn't really exist several years ago,” he said.

Also, in the past general partners were not as supportive of secondary market sales of limited partnership interests in their funds as they are today, he said. General partners likewise have become more accustomed to the real estate secondary market and now make it easier for limited partners to sell their fund interests, Mr. Giller explained.

Landmark's Mr. Sunday said the “significant uptick” in sellers comes from the trend of asset owners pruning their real estate manager relationships. “Some pension funds, endowments and foundations are looking to resculpt their portfolios by reducing the number of GP relationships,” he said. “Banks have sold some assets to comply with regulatory measures, and others are looking to sell down legacy funds with managers.”

When CalPERS announced its potential sale in June, Paul Mouchakkaa, senior investment officer for real assets, said in a news release that plan officials were selling “to reduce costs, risk and complexity across the CalPERS fund.”

“For the real estate program, it will enable us to invest in assets and managers that are more aligned with our current strategy,” Mr. Mouchakkaa said in the release.

“Real estate has a long way to catch up with the private equity secondary market, but there is no reason it shouldn't,” Mr. Giller said. “Having new participants in the market creates liquidity; that drives sellers to come to market. Sellers look at the attractive pricing their colleagues are getting.” n