Can anyone please explain in depth what participating in a real estate secondary really is? I have been doing extensive research but have yet to get a clear picture in my head with examples what companies who start secondary funds do with their deployed capital.
I would appreciate any insight. Thanks.
Might be missing something in your question, but secondaries provide liquidity for PE investors by buying interests in funds from other LPs (as opposed to buying them in primary offerings from sponsors). For example, endowment A invests in a fund with a 10-year life, and 5 years into the investment needs to reallocate capital out of whatever that fund does, they could sell their stake to a secondary fund. At this point, some of the fund should be deployed so the 2ndary fund should be able to value the stake based on assets in the fund plus the sponsors plan for the rest of the life of the fund.
I don't know anything about the mechanics of 2ndary investing though, maybe someone else can chime in on that. Does the 2ndary just replace the original LP? Can the original LP divide their stake and sell off pieces? Can GP veto the sale based on reduced credit quality? etc...
Great first answer on this discussion. I now have a better picture in mind after your example mentioning the endowments. That seems to make sense. Landmark Partners is one of the most experienced participants in the private equity secondary market, and they recently bought Harvard's real estate interests....
I am just curious to why Landmark takes this strategy. When buying into these funds, they are usually buying assets at a discount to NAV and I am trying to specifically understand how that works.
The transactions at this point in the secondary market life cycle are very commercial and for the most part I would say that usually whole interests are sold with a smaller number of chunky commitments being subdivided. GPs can veto for a variety of reasons.
As mentioned above, a secondary buyer provides liquidity to an existing LP and replaces that LP in the fund, assuming the burden of uncalled capital commitments (ie. $50mm commit, $30mm called, $20mm uncalled).
As for valuation, funds are priced based on a % of net asset value. For example, say a fund has $500m of net assets on their books. If a buyer likes the assets and thinks they have measurable appreciation ahead of them prior to harvesting, the buyer will pay a premium above NAV, say 110% (for context, that would be a primo fund as most NAVs have some upside already baked in the figure). If the LP commitment is $50mm, the purchase price would be $55mm with the hope the assets appreciate in excess of their required return. In a more normal case, a discount is applied to NAV to capture risk/time value associated with the projected future cash flows. In Landmark's case, they have the ability to buy assets they would otherwise not have exposure to (assuming they are not an existing LP) or increase exposure to manager they like. Also a way around investing in PE assets without assuming blind pool risk.
Thanks a lot for a thorough explanation! What does a case study for the Real Estate Secondaries look like? Do you value each asset in the portfolio and then apply some discount? How do you treat management fees, carry and other things?
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