Secondaries - A fast growing industry offering liquidity for sellers and superior returns for buyers.
Secondary transactions are the purchase of interests in portfolios, funds, and/or single assets from existing investors. They can represent an attractive opportunity as the investment can be made after some of the startup or completion risk of a project has ended, while reducing the time to receive distributions, while taking advantage of the counterparty's need for liquidity.
Real estate secondaries represent approximately 10% of the secondaries market generally (including private equity funds, hedge funds and real estate) which have continued their 25%+ annual growth over the last 20 years.
Annual Volume of Secondary Market Transactions
A COMPETITIVE MARKET
These transactions are often consummated at a discount to the net asset value (NAV) but have of these assets and therefore provide investors with some unique advantages.
To the extent you can buy into assets that are a few years into their typical life cycle, your risk is reduced relative to thr an investment made in the initial stages of a project or fund.
By acquiring such assets at a discount to NAV, you can often generate
significant cash-on-cash returns to your equity and a return profile more akin to a value-added strategy, but with core-like property risk.
BENEFITS TO THE INVESTOR
From the investor’s perspective, investing in a real estate secondaries can yield a number of important benefits. These include:
As transactions completed to invest a secondary program can involve
portfolios with many in-place assets, investors quickly achieve far more diversification than if they were building a portfolio of a similar size themselves, on a primary basis.
Very often, the more mature and seasoned funds that are acquired via secondary transactions are at a point in their lifecycles where they are generating income and disposition proceeds, leading to an accelerated distribution pattern as compared with primary funds. This results in faster return of capital and overall shorter duration for secondary funds.
The inefficiencies in the real estate secondary market offer smart buyers the opportunity to acquire fund interests at a discount. By acquiring exposure to underlying real estate assets at higher cap rates and at a lower basis than what is being achieved in the direct property markets provides some protection in the event of a market downturns.
Eliminate the J-curve effect. Investors in secondary programs will often see early uplifts in value, which result from recapturing the discount to NAV (and more importantly the discount to intrinsic value) negotiated by the buyer. This, combined with earlier distributions than original investors would receive, can reduce or eliminate J-curve effects. This can have a substantial impact on the IRR calculations of investors.
De-risking and value-based.
By investing in a property during the later stages of its business plan, a secondary buyer can transact at a point in time when much of the development or repositioning risk has already been mitigated, thus altering the risk profile of a value-added or opportunistic strategy to one with more core-like characteristics. In addition, the ability to source and structure transactions offers the opportunity to create value “on the buy”, reducing, though never eliminating, reliance on market fundamentals to drive returns.
BENEFITS TO THE SELLERS
The secondaries market allows investors with holdings in these funds to exit part of their portfolio so they can reallocate capital to other opportunities.
Current sellers are mostly often focused on reducing the number of general partner relationships and, in turn, fees paid to fund managers.
Sellers also may seek to alleviate regulatory pressures by reducing the number of private market investments.
The market for Secondaries represents only single digits of the entire universe of private equity investing. However, given the increased visibility that it offers as to the investment, the shorter timeframes to realize cashflows and the slight pricing arbitrage opportunities that they often offer, the market for Secondaries is expected to continue to grow.