November 25, 2016
Interviewed by: Matt Malone
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The Current Trends in Secondaries & Direct Investing

Two industry veterans discuss the market for secondaries and direct investments, the pricing environment, and more.

Two industry veterans discuss the market for secondaries and direct investments, the pricing environment, and more.

The Current Trends in Secondaries and Direct Investing
With Metropolitan Real Estate and TH Real Estate

Matt Malone, Privcap:
Hi, I’m Matt Malone from Privcap. I’m very happy to be joined today by Sarah Schwarzschild of Metropolitan Real Estate, part of Carlyle, and Adriana de Alcantara of TH Real Estate, part of TIAA Global Asset Management. Welcome to the program.

Unison: Thank you.

Malone: Today, we’re going to talk a bit about the deal environment. I’d love to start by getting your sense of where we are at in the cycle.

Adriana de Alcantara, TH Real Estate:
We feel that real estate is well positioned for the foreseeable future, for several reasons. One, because construction has been in significant decline during 2010 and 2014 in the wake of the great crisis. In addition to that, construction is right now weak and is expected to remain weak because the Federal Reserve is watching very closely consumer bank lending. What that means is that the market is well balanced and there is no overhang of space, which means that rents shouldn’t fall.

The second reason is because the spread between cap rates and treasury yields are above the long historical average. The third reason is that the markets are still very healthy. Employment growth is quite robust. The economy is still very solid and there is consumer spending as well. These are all drivers for real estate.

Malone: Sarah, what are your thoughts?

Sarah Schwarzschild, Metropolitan Real Estate:
I would just add to that that while I do agree that the underlying fundamentals are generally strong across most of the markets, that we are seeing capital markets becoming quite robust. And so cap rates are at historic lows, and while they are above interest rates, they still do represent relatively robust pricing. And this can be good for those who are net sellers into this market, but it can create an environment that’s hard if you are on the buy side.

de Alcantara: I agree with you, that’s a very good point. But I would add as well that real estate offers diversification. It has low correlation to stock and bonds. So it’s a very good addition to the portfolio, to a multi-asset class portfolio.

Schwarzschild: Yes, I agree with that as well.

Malone: So in the context of the cycle, one question that obviously comes up, where are the opportunities whether it be by sector or type of investment. Adriana, what do you feel are the most compelling opportunities today?

Schwarzschild: The Seattle markets have been a top performer in the last 10 years. Vacancies are at 5%. In the last 20 years, vacancies were at 4.5%—very low. The economy is very strong, with strong demographics, young population and very diversified economy. And there is institutional stock and institutional investors, which means liquidity, which is very important for us.

The last sector that we like very much is the industrial sector—the last mile, warehouse distribution center close to big pockets of population. We all know about Amazon and how easy it is nowadays to open your app in your phone and just have everything delivered in one second to you. E-commerce has been booming and that’s the sector that we have been very active on as well.

Malone: Sarah, what are your thoughts on finding opportunity in the context of the type of investing that you do?

Schwarzschild: We take a slightly different approach. Metropolitan operates more opportunistically across the globe to find different opportunities. We do have various strategies that we employ and one of them is real estate secondaries. That’s buying LP interests in a real estate fund after the fund has closed to new investors. That’s a very new market and it’s an inefficient market, unlike a direct property market, which is a more efficient market, because real estate secondaries are so new and because you’re buying in through an LP interest, there is a layer of lack of transparency. There is an asymmetric dynamic in the market where some people have more information and others don’t have as much information. That can lead to attractive buying opportunities.

Malone: Do you see any shifting in investor preferences for their asset allocation?

de Alcantara: One of the challenges we have on the acquisition side, as said, is that the markets are still very competitive. We look at all deal sizes, from 30 to larger deals above $200 million, and it’s true that larger deals are less competitive than it used to be a couple of years ago. The pool of buyer is not as deep as it used to be; however, in the smaller sizes, $30 to $100 million is still very competitive.

On the selling side, we think execution is key. Right now, there are many bidders out there; however, some just go to the final rounds and then have their bids rejected by their boards. That is important and, in fact, that is good as well for us because in TIAA, we have a very good, very strong reputation in the market that once we get awarded the deal, we perform as well. We execute on the deal unless, frankly, there is something fundamentally wrong with the asset.

Schwarzschild: We’ve actually seen the same in the secondary market. There are some sellers who are willing to give up a small amount of economic value by accepting a lower purchase price for certainty and surety of close. If we go to the seller, we know the underlying manager, we’ve done our underwriting, we have a hard bid. We can shake loose that deal versus another buyer who maybe has a higher bid, but is not as far along in their process or doesn’t have that same strong relationship with the underlying fund manager.

de Alcantara: Yes, I agree. Sometimes it’s not about the best pricing, but really someone with good reputation. We are seeing that in the market as well.

Malone: What are some other obstacles in terms of bringing buyers and sellers together, whether it be in the secondary market acquiring properties or selling properties? And how do you mitigate those challenges?

Schwarzschild: I agree that you have to be very disciplined in your underwriting and sometimes your price is not going to be as high as it was in an environment we had maybe a few years ago. However, there are different ways you can bridge bid-ask spread. You can use a deal structure. There’s various different structure deals that exist in the secondary market and that can help the buyers achieve the price they’re looking for and also help the real estate secondary buyers get there as well. An example of that would be a deferred payment plan—that’s where you pay a certain amount at close and a certain amount in the future. For the seller, I’m able to offer them a price that’s higher than I would otherwise because I don’t have to call that capital from my underlying investors until the future. So, it gives me a boost to my returns. It also helps the seller get there on their side.

Malone: On the direct side, the buying and selling of property directly, what are some of those particular challenges and how are buyers and sellers overcoming them?

de Alcantara: What we are seeing is a lot of off-market deals as well. As mentioned before, certainty of execution is key. We do have a lot of relationships with third parties, so sometimes we get approached: “Hey, do you want to do this deal?” The same [happens] on the selling side as well. I see the market going much more to that type of structure.

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