Trading Private Real Estate: Liquidity is no Barrier

In the first of three pieces looking at the benefits of secondary trading of private real estate, we examine the level of liquidity the market has seen over the last ten years.

• At the aggregate and fund level, we estimate that broadly speaking, 3-4% of the net asset value of the secondary fund universe is traded each year – for comparison, this is about the same as the UK housing market.
• As the private funds market has evolved, so too has deal flow, and now long income and non-UK funds account for an increasing share of volume, at the expense of UK balanced and specialist funds.
• Over the medium term, there is a decent relationship between fund performance and liquidity; in other words, the better a fund is performing the more likely there is to be active two-way interest in the secondary market, allowing investors to transact.

PropertyMatch has traded over £1bn in six of the last seven years. As clients’ focus has become increasingly global, so the share of non-UK funds has grown, peaking at just over 50% of 2019 volume, as shown in Figure 1. European trades account for the majority of non-UK volume. Within the UK, the share of volume accounted for by Long Income funds has grown rapidly over the last few years, at the expense of Balanced and Specialist funds, so that in 2019 Long Income funds were the single largest grouping in the UK, at just over £350m. Balanced fund volumes trailed off to just over £200m, having been at or around £400m in the previous six years.

Figure 1: PropertyMatch trading volumes by fund type

Source: CBRE Research, PropertyMatch. Note, 2020 data is for H1 2020 only

Establishing the rate of turnover of the fund groupings is problematic. It requires knowledge of the value of the respective universes. Data on this can be obtained from the MSCI/AREF UK Quarterly Funds Digest. However this may understate (because not every fund is a contributor) or overstate (because some funds listed are not tradeable) the Universe. What the data does show is the stabilization in value of Balanced funds, the decline of Specialist funds and the rise of Long Income funds over the last few years, so that in very rough terms they might be said to account for 60%, 20% and 20% respectively of the total Universe.

By dividing ProperytMatch trading volume by MSCI data on the value of the various Universes, it is possible to arrive at estimates of market liquidity for the three UK fund categories. Over the last ten years (six for Long Income), Specialist funds have been most liquid (2.6% of value traded on average each year) though this has been on the decline. Long Income follows at 1.7%, though this is arguably trending upwards. Balanced funds trail at 1.2%, but here it is likely that the figure understates the truth because the MSCI Universe of Balanced funds contains a number of entities that are not tradeable on the secondary market.

Rather than looking top down, a better way to estimate liquidity may be bottom up. For those funds that have been traded in the 2010-2019 period, and that contribute to the MSCI/AREF UK Quarterly Funds Digest it is possible to compare trading volume and net asset value. On this measure, the median liquidity figure is unchanged for Long Income (1.7%), but higher for Balanced (2.9% versus 1.2%) and Specialist (3.4% versus 2.6%). As UK Long Income liquidity is likely constrained by a dearth of sellers, it seems reasonable to assume that all groups’ true liquidity is likely around the 3-4% mark.

Figure 2: PropertyMatch liquidity at fund and universe level

Source: CBRE Research, PropertyMatch

MSCI also produce estimates of the size of investment markets in all countries they operate in. CBRE tracks investment market volume in these markets. By combining the two it is possible to estimate turnover in the direct market over the 2010-2019 period, for comparison with that of the private real estate fund market. As would be expected, the direct market is more liquid; typically 8-12% of a country’s commercial real estate is transacted each year, versus the 3-4% turnover seen in the secondary market for private funds. This latter range however compares reasonably well to liquidity in say the UK residential market.

Figure 3 compares, for the last five and ten years collectively, fund total return and trading volume (as a proportion of NAV) of 11 UK Balanced funds. (Those that have been traded via PropertyMatch and for which performance history exists in the MSCI/AREF UK Quarterly Funds Digest). A strong relationship between performance and liquidity would indicate that the performance was driving liquidity. For the last five years there is a reasonably strong positive correlation, but not over ten years. This may indicate that as the market has matured, a relationship between performance and secondary liquidity has evolved. The relationship does not exist on a one year level.

Figure 3: PropertyMatch liquidity versus performance at fund level, UK balanced funds

Source: CBRE Research, MSCI, PropertyMatch

Figure 4 performs the same exercise for specialist funds, splitting them up along sector lines – grouping the better performing Logistics & Alternatives and the weaker-performing Retail & Office. It is then possible to discern relationships between performance and liquidity over the longer term. There is a strong positive correlation over ten years and a weaker positive correlation over five years between performance and liquidity in the Logistics & Alternatives funds grouping. The Retail & Office grouping actually shows a strong negative correlation between performance and liquidity in the last five years; volume in weak funds may have been driven by opportunistic buying at sharp discounts.

Figure 4: PropertyMatch liquidity versus performance at fund level, UK specialist funds

Source: CBRE Research, MSCI, PropertyMatch