The real estate market continues to be under pressure: interest rate policy, inflation and increasing regulation with regard to ESG criteria mean that many institutional investors are reviewing and reallocating their real estate portfolios. Funds with older existing properties in particular are confronted with high modernisation costs, which are becoming necessary in the course of increasing sustainability requirements.
But not all investors want to take advantage of these revitalization opportunities – and prefer to get out. In addition, many investors feel that they are overallocated in certain types of use and are looking for ways to reduce their positions. But what to do if the direct redemption of a special AIF share is not an attractive option? The answer could be the secondary market, which has so far been established primarily in private equity and is now also gaining in importance in the real estate sector through the initiative of the German Fund Exchange.
Status Quo: Challenges for Institutional Real Estate Investors
However, the procedure is quite lengthy: the minimum holding period is too long, the subsequent announcement of the return and the expiry of the deadline until the return – which, moreover, is only possible against a flat-rate return discount. In addition, liquidity in special AIFs often poses a problem: investors’ return requests often cannot be met immediately because the fund company works with tight cash reserves to leverage maximum return potential and cannot or does not want to sell the underlying properties quickly enough at reasonable prices. In particular, a forced sale in order to have enough liquidity available for the payout is often a bad deal for the fund company at the respective conditions, which jeopardizes the long-term success of the fund.
A possible, but often undesirable, solution would be the complete liquidation of the fund. On the one hand, this entails considerable risks, especially if the properties have to be sold under unfavourable market conditions, and on the other hand, it disadvantages investors who do not want to exit and would lose their stake in the properties.
This is exactly where secondaries come into play – a market that offers institutional investors the opportunity to sell their shares in real estate funds simply and at short notice without having to sell the underlying real estate of the fund company.
Exit solution with potential
Secondaries are already established in private equity investments, but less so in real estate AIFs, especially at the international level. The principle can be transferred one-to-one: The secondary market allows institutional investors to easily sell their shares in real estate funds to other investors without having to comply with redemption deadlines or having an impact on the fund’s liquidity. Secondaries not only create liquidity for sellers and maintain discretion vis-à-vis the fund company and co-investors, but also offer new investors an attractive opportunity to gain access to existing fund structures with a well-documented track record.
The principle is simple: an investor who wants to sell his shares in a real estate fund offers them on a suitable secondary market such as the Private Markets fund exchange. The purchase option is offered discreetly, whereby interested buyers can view the framework data of the offer and communicate their intention to buy. Afterwards, both parties exchange information about further key figures in a closed data room and agree on a price.
The advantage for the seller is that he is not dependent on the fund company buying back his shares. Instead, trading takes place directly between investors, which speeds up the process and stabilizes the market as a whole.
Discretion as a key factor
For institutional investors, discretion is of central importance when communicating intentions to sell and buy. The sale of shares in special AIFs should be carried out as far as possible without major fanfare in order not to send negative signals to the market or endanger one’s own reputation or the fund’s reputation. This is a clear advantage over a direct return to the fund company, which could potentially culminate in the liquidation of the fund. In addition, a discreet sale via the secondary market can avoid the impression that an investor is in financial difficulties or has lost faith in the real estate market. Instead, the sale is perceived only by the buyer as a strategic portfolio adjustment, which is beneficial for both the seller and potential buyers.
Legal and market-specific hurdles
Despite the obvious benefits of special AIF secondaries, there are also some challenges that need to be overcome. One of the biggest hurdles is the legal framework. The trading of shares in real estate funds is subject to strict regulatory requirements, in particular with regard to the transfer of shares and compliance with the requirements of the Federal Financial Supervisory Authority. Another factor is market maturity. While the secondary market in private equity is well-established and relatively accessible, specialty AIF secondaries are still in their infancy. For a long time, there was a lack of standardised processes and a well-known marketplace that could further establish secondary market trading in special AIFs.
In addition, potential buyers are not always easy to find. Although the market is growing, it is not yet fully developed. The sale of shares can therefore tend to take longer than for more liquid securities. Nevertheless, current developments show that interest in real estate secondaries is growing and the market is likely to become more liquid – especially as more and more institutional investors recognize the mutual benefits of this market segment.
Secondary market as a growth opportunity
The secondary market for real estate funds offers attractive opportunities for both sellers and buyers. Sellers can sell their shares discreetly and on fair terms. Buyers, in turn, gain access to proven real estate funds, currently often at more favorable conditions than with a new investment. Nevertheless, legal and market-specific hurdles must be overcome in order to further establish the secondary market. Standardization and broader market acceptance are the keywords here. If this succeeds, real estate fund secondaries could contribute to stabilizing the entire real estate market.
