US funds; liquidating...

Secondary real estate market quietly ramps up

Thu Sep 20, 2007 9:15am EDT

NEW YORK (Reuters) - The dizzying pace of commercial property acquisitions over the past year has down-shifted into a new phase as real estate investors shuffle their portfolios and try to resell holdings.

The normally illiquid secondary real estate market should see significant new interest as antsy limited partners consider selling to more enthused institutional investors or new funds dedicated to the secondary market.

"For the first time in several years institutional limited partners are taking a hard look at their real estate portfolios and deciding what they want to keep," said Scott Landress of Liquid Realty Partners, a San Francisco-based firm that has acquired more than $1 billion in secondary property interests.

A wobbly economy has spooked commercial property investors as some rental rates hit all-time highs and wary lenders pulled back after years of issuing cheap debt that pushed up prices paid per square foot.

Institutional investors are also reckoning with a drop in the stock market that disrupted the balance of investment portfolios, leaving some funds over-exposed to real estate relative to their targeted allocation.

Buyers in the secondary real estate market continue to be burdened by relatively small investments that must be pieced together to build a portfolio of meaningful size. But they are likely to see more liquidity as sellers come to market not only for profit-taking, but also to diversify their holdings or reposition their investments in order to extend a fund's life.

LOOKING TO SELL

An eruption in real estate investing that trailed the property boom now has managers revisiting their portfolios for style, sector and overlaps with other funds.

"We are in dialogue with a number of large institutions looking to sell real estate portfolios," said Michael Hoffmann of San Francisco-based adviser and placement agent Probitas Partners. "Some positions will be sold off for administrative efficiency, as institutions haven't grown their staffs to match the growth in real estate fund manager relationships."

The California Public Employees' Retirement System (Calpers), the largest U.S. pension fund, has considered steps to increase efficiency by reducing managers, according to information officer Clark McKinley.

"We have the same problem in real estate that we have with private equity: it grows like top seed," McKinley said. "You keep getting partners and new partners and pretty soon you've got scores of them and limited staff."

Fund managers are also looking to expand real estate portfolios overseas to tap relatively attractive markets.

"Increasingly investors are seeking international exposure, so it's likely there will be more secondary trades of domestic funds and reallocation of capital internationally," said Edward Casal of real estate investment firm Madison Harbor Capital.

Indeed Calpers, with 8 percent of its portfolio, or $20 billion, allocated to real estate, recently recommended over time making half of all its property investments abroad.

CAPITALIZING ON INCREASED FLOW

Liquidity in the secondary market may give both general and limited partners room to maneuver through tough times.

"This would be a bad market to sell into," said Bill Atwood, executive director of the Illinois State Board of Investment. "It's got to be difficult if you're a general partner coming to the end of a fund. It wouldn't surprise me to get a call from a general partner asking for a one- or two-year extension."

With motivated sellers often unloading at a discount, secondary transactions are often kept quiet -- making them tough to track.

To indicate the potential size of the market, Landress points to Liquid Realty's acquisition last year of a portfolio of interests in 10 UK property funds valued at $775 million at the time of closing.

This year the company bought real estate fund interests valued at $60 million from a European corporation that decided to liquidate its portfolio, Landress added.

With real estate positions often substantially smaller than those examples, historically it's been difficult to combine enough investments to make secondary real estate acquisitions an attractive business.

But with more interest, the secondary real estate market could eventually resemble the one for private equity positions -- which set an annual fund-raising record of $13 billion in the first six months of this year, topping last year's total of $6.1 billion, according to Probitas.

"Many secondary funds oriented toward private equity will look to bring on real estate talent to capitalize on this increased flow of fund positions," said Hoffmann of Probitas.