CRE Investors Want Out Of Funds. The Secondaries Market Is Lining Up Billions To Help Them

As commercial property assets fall in usage, prices and valuations, their investors are looking for a way out of their commitments.

Enter: secondary funds.

REITs and other property funds typically lock in backers for at least five years. If investors want to withdraw those funds, they are usually limited on how much, and withdrawal caps have gotten more intense over the last year. 

These investors are increasingly turning to secondary funds, which buy private stakes that otherwise would be a hard sell and flip them to bargain-shopping buyers. 

As pain is increasing in real estate and owners find themselves unable to cover their debt, secondary funds targeting the industry are on the rise, The New York Times reports.

Goldman Sachs announced it raised $3.4B for its real estate secondary fund in June — the largest such fund ever. Ares closed a $3.3B fund in December, and Blackstone's $2.6B fund closed in November. 

Real estate secondary funds closed $9.8B in transactions last year, Ares reported, and advisory PJT Partners predicts real estate secondaries could triple by 2030 because of how distressed the industry is. Even if interest rates are cut soon, when CRE loans mature, borrowers will be hit with financing costs that are higher than they have been in 15 years. 

Managers of secondaries told the NYT the assets in the funds they buy stakes in are generally doing well and simply running into refinancing woes.

Secondaries give investors the opportunity to snap up assets that would usually not be available for purchase — and at a steal — from those looking to cash out early. Buyers can get access to stabilized assets and can broaden their holdings, since a typical fund can hold stakes in hundreds or thousands of buildings across property types and regions. 

The deal isn’t so sweet for the sellers. The average secondary deal across industries came with a 26% net asset value markdown in the second half of last year. Investors wanting to free up liquidity by selling out of a fund have to be willing to take a substantial haircut.

This secondary market has shifted as the pandemic and interest rate hikes affected every sector of real estate. The rate of deals done directly with developers and portfolio managers has increased, while those done with limited partners have slowed, partly due to fund managers being unwilling to cut down the worth of their assets.

Investors with stakes in private funds have less of an incentive to sell if they can afford to wait for a market recovery, but funds that cut down distributions and withdrawals due to market headwinds force cash-strapped investors to sell their stakes.

While publicly traded REITs were quick to write down their assets' value when the market turned, private managers were slower to do so.