“Secondaries” or secondary transactions sound complex but are quite simple. In fact, if you have ever shopped for an item on Facebook marketplace or Craigslist you may have been involved in a secondary transaction yourself. Let’s use shoes as an example. Often when you buy a pair of shoes, you go direct to the brand or a store that represents that brand. In doing so, you participate in a primary transaction i.e. you exchange dollars for that new pair of shoes directly from the source. However, if you log on to your favorite classifieds site and buy that pair of shoes from an individual, that is a secondary transaction. Supply and demand can greatly impact the price that you pay. If the shoes are limited edition and no longer available, you may have to pay a premium. But if they are simply no longer needed you may be able to buy them at a bargain price.
Real assets funds operate in much the same way. In a primary transaction an investor subscribes to or redeems their units directly from a real assets fund. In a secondary transaction an owner of a fund sells their holding in that fund to another investor.
Secondary transactions can be used to buy into established real assets portfolios already in the market with proven track records, and are often available at discounts compared to original intrinsic value and their prevailing market value. It is possible for investors to generate outperformance or “alpha” against broader real estate markets by negotiating a much more reasonable price for the assets than if they bought it in the primary market.
Secondary transactions can also be useful as a tool for portfolio management. Secondaries offer a more flexible way to invest or divest from real assets versus the primary market. This can enable investors to actively manage exposures and concentrations. Capital may be deployed more quickly versus the primary market and into more mature investments. Investors can therefore reallocate capital towards more compelling opportunities and avoid the typical capital allocation ramp up period or ‘j-curve’, more typical of primary funds. By investing in portfolios with existing track records, investors may be able to mitigate the risks that come with investing in new portfolios that have yet to be proven resilient through periods of market fluctuation.
The recent era of rising and unpredictable interest rates has created a significant increase in uncertainty in real estate secondary valuations. However, uncertainty also offers alpha generating opportunities when forced sellers are met with thoroughly educated buyers, with dry powder to invest. Recently, we have seen investor sentiment improve as private market valuations in open ended real estate funds declined and bid/ask spreads narrowed.
With uncertainty comes fewer transactions as buyers are nervous to ‘catch a falling knife’. However, uncertainty also offers alpha generating opportunities when forced sellers are met with thoroughly educated buyers, with dry powder to invest.
Pension plans can offer an interesting example in either case. As an example, consider a plan that may be a forced seller due to terminating their plan and creating the need to liquidate positions that don’t otherwise offer liquidity in the time required. Vice versa a plan with a long time horizon and ample liquidity may be able to step in and provide liquidity for the right price. In recent years, we have seen more sellers and buyers meeting on the open-ended real estate secondary market, increasing secondaries transactions volumes.
July 2009 to November 2024
Source: PropertyMatch
Figure 1: Trade volumes of open-ended real estate funds has increased
Focusing on open ended real estate funds trading activity, Figure 1 demonstrates their continued growth.
The majority of this activity is driven by market dynamics and investor sentiment within open ended funds. During favorable market conditions, entry queues typically lengthen for investors trying to get into a fund. Volatile markets typically lead to longer redemption queues for investors trying to redeem from a fund. Rather than stay in these queues, investors might use the secondary market for immediate entry or exit to or from a fund. Of course, this expedited entry or exit comes at a price, which is agreed between the transacting parties via a premium or discount relative to the Net Asset Value (NAV) of the fund. These transactions on the secondary market provide liquidity and can allow for investors to opportunistically pursue investment opportunities.
In the last few years, redemption queues rose within open ended real estate funds. Investors were cautious as private market real estate valuations lagged in late 2022 and into early 2023. This caused bid/ask spreads to widen and secondary activity to decline. As shown in Figure 1, quarterly trade volume dropped from ~$700 million (2Q22) to less than $150 million (3Q22). Recently, we have seen investor sentiment improve as private market valuations in open ended real estate funds declined and bid/ask spreads narrowed. As shown in Figure 2, the average discount in secondary trades relative to NAV improved from around -11% (early 2023) to -5% (3Q24):
July 2009 to November 2024
Source: PropertyMatch
Figure 2: Average premium or discount to NAV of real estate open-ended funds has improved
While we continue to see market declines in segments of real assets, we do observe rising confidence among investors as the market approaches the trough. We expect more primary real assets transaction activity to occur and secondary market volume to increase. In our opinion, this long-term trend of increasing secondaries availability, married with a recent uptick in investor sentiment offers an opportunity for nimble investors. Asset owners will continue to view secondaries as a solution for liquidity. However, the most opportunistic investors will also benefit from the value secondaries provide to enable more efficient capital allocations in their real assets portfolios and as a potential alpha generator. This comes with inherent market timing risks as the secondary market environment can change quickly as it continues to become more dynamic.
At WTW, we have been advising, managing, and researching in real assets for over 30 years. We use the same opportunistic approach to secondaries for our clients’ portfolios. Leveraging our global platform to find attractive opportunities and support clients with varied objectives to execute a differentiated approach to real assets.
If you have any questions or would like to know more, please contact us here.
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