February 22, 2016
Interviewed by: Zoe Hughes
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Why RE Needs a True Secondaries Market

Jim Valente, head of real estate at MSCI, says the private real estate investment industry is still lagging in developing a genuine secondaries market, despite highprofile fundraises and deals, not least Blackstone’s $3B acquisition of 43 fund interests from the California Public Employees’ Retirement System in November 2015.

Jim Valente, head of real estate at MSCI, says the private real estate investment industry is still lagging in developing a genuine secondaries market, despite highprofile fundraises and deals, not least Blackstone’s $3B acquisition of 43 fund interests from the California Public Employees’ Retirement System in November 2015.

Why RE Needs a True Secondaries Market
With Jim Valente of MSCI

Zoe Hughes, Privcap: I’m joined here by Jim Valente, Head of Real Estate at MSCI. Thank you so much, Jim, for joining me today.

Jim Valente, MSCI: Thank you for having me.

Hughes: As we look back at the performance of U.S. real estate in 2015, I think it’s fair to say it’s been a pretty good year. For more than a year—18 months—everyone has been expecting a real compression in returns, but the good times continue to roll. So, Jim, how long will these good times last?

Valente: I would say we’re fairly late in the cycle. When you look at yield rates today, the income returns on properties, they’re at the low end of the distribution we’ve seen. But then, leverage is low and I think that contributes to keeping the cycle going as long as the economy does. But to sit and think we’d be, three or four years from now, still in a growth cycle is probably unrealistic.

Hughes: So, we’re late in the cycle. What does this really mean for institutional investors as they look to real estate and they look to making investments 2016 and beyond?

Valente: For different investors, it means they’re going execute different strategies. I think right now for investors that are starting to move out the risk spectrum, it’s starting to get late when you look at the duration of closed-end funds in that space. Five to seven—


Hughes: —And we have seen a move, particularly into the value-add. Investors are really looking at value-add strategies now.


Valente: So, depending on the type of value-add strategy you’re executing, whether it’s rehabbing/re-positioning buildings and adding value through that or you are doing some of that and some development on the edge. Clearly, in a lot of markets, the current prices that existing assets are trading at support new construction. To the extent that they have an expectation that the economy will continue as they deliver that new property, or complete the business plan to turn the asset around, they should pursue those. But, again, I think you have to think about what your risk profile is and what your strategy is.

For more core-type investors that are looking for more income, now’s probably a good time to buy long-lease assets. You’re late in the cycle, and if you can buy 10 or 15 years a term, you’re probably going to get yourself through the next downturn and probably…get a higher yield on that asset because today investors are paying for vacancy. They’re paying for that opportunity for near-term lease roll to move rents.

Hughes: Is there a realism over the returns that are actually going to come out of real estate given this late cycle?

Valente: I think we have a tendency to look backwards at returns and look at returns today with an expectation. We’ve had a great run of returns and, when direct real estate is doing double digits, unlevered and leverage is free, you tend to get really nice returns. I think depending on what the expectation is, when you look at value-add, opportunistic strategies and the marks they set of, “I’m going to get a 15% or a 20% return on this.” Given where we are in the cycle and the duration of those types of funds, the inability to hedge the downside of that calls into question—for me, at least—[whether] I can really expect that at this point in time.

Maybe if I had gone into that fund two years ago, you would have a realistic expectation of that. But, given that you can’t hedge that and we’re late in the cycle, I think there’s added risk.

Hughes: I like your point in terms of hedging the downside. I think [with] institutional investors, LPs—one of the big challenges for them is, as they look at where we are in the cycle and as they look out, particularly if they’re going into closed-end funds, how do they create liquidity? What tools are really available to them? What are some of the solutions for them, given where we are in the cycle?

Valente: Growing development of the secondaries market in the U.S., it’s much stronger in the UK, if you go look at that experience over there. But I think that is an opportunity for investors. There’s some folks out there really working that market now and trying to develop I, but there are still challenges there because either the LP has a prohibition against doing it or their consultant doesn’t support them going into secondaries. But, there are people out there making a market in that. There are trades occurring. It’s not a huge piece of the market.

I look back to early 2011, I was with an individual who runs the real estate for a big endowment, talking about he couldn’t get out of the closed-end funds he was in. And the prices had recovered so that he could get all his capital back, but the manager was focused on repairing their performance track record. A secondaries market cures that.

Hughes: Because some people are saying that the secondaries market is back. Obviously, Blackstone has done a huge deal, $3 billion for CalPERS secondary interest. We’ve seen some fund managers raise really large, billion-dollar funds for secondaries. Is that market not back or do you still think there’s a huge way to go?

Valente: I think there’s two parts of it where you’re looking at people raising money to buy those shares, or you’re looking at Blackstone doing a big one-off type deal like that or a big portfolio deal like that. That’s different than having an actual market where there’s buyers and sellers of shares of funds, whether they’re open-end or closed-end funds, or their joint-venture interests. But an intermediary that plays that role similar to having in many derivatives markets or stock markets, where you have broker-dealer type agents that create markets and people can get in and out of positions.

I may want $200 million of this or I want to sell $100 million of this or $50 million of that type of any interest. That type of market really still hasn’t developed yet. I think that’s where—if you want the benefit of the control and lower volatility of private real estate and the benefits of that income and capital growth long-term, versus an REIT market or…cash and equities—you can park the money. That’s what will create that in the U.S., and I think it’s important for our market to develop over the coming years.

Hughes: Do you see it already starting? Are we in the starting lineup, as it were, for this?

Valente: I think we’re early on. We talked about baseball games before. We’ve probably got the second batter up in the first inning, if that’s a good way to put it. But I think the more the market does to promote that, the more liquidity you get, the better the pricing, the more efficient the market, greater transparency comes in. I think it’s just better for everybody.

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