Second hand

• Secondaries fundraising hit $91.2bn in 2023, three times that of 2022
• Performance-wise, secondaries compare well to direct private equity, and recent vintages generated even higher IRRs
• Secondaries account for less than 1% of total market turnover, and will likely increase

Second hand goods are quickly becoming the newest trend in town with major brands like Zara, H&M, and Lego tapping into the booming second-hand economy, alongside start-ups such as Vinted, Depop, ThredUp, and Vestiaire Collective. Over the weekend it was reported that TPG is in talks to buy a stake in Europe’s largest second-hand fashion site, Vinted, at a €5bn valuation. Celebrities like Bella Hadid and Rihanna, along with TV shows like Love Island, have popularised the trend towards used and “preloved” items, driven by cost and environmental concerns. Bain & Company estimates that second-hand luxury sales grew by 125% between 2017 and 2023, significantly outpacing new luxury sales at 43%. Jesper Brodin, chief executive of Ingka, the main operator of Ikea stores, says that the group has an even higher market share in the second-hand sector than for new products.?

The rise of second hand goods mirrors a trend in the secondary market for real estate funds. In the Capital Allocators podcast episode ‘Secondaries in Private Markets’, Nigel Dawn, Global Head of Private Capital Advisory at Evercore, explains how the perception of selling a second hand GP stake has evolved. Previously, requesting a sale was akin to the awkwardness of asking for a divorce, however the stigma surrounding the sale of LP interests has diminished significantly. What was once viewed primarily as a last resort for distressed assets or for offloading non-core portions of a portfolio has now become a strategic tool for repositioning portfolios. The secondary market has matured considerably, with its level of sophistication now matching that of the LPs it serves.

The development of the secondary market has come at an opportune time, with private capital under strain. According to a Financial Times report, the traditional "two and twenty" fee structure has become less common. Private equity fundraisers are now offering discounts to attract large investors, as fundraising in the sector is down by more than a third through to July of this year. Preqin reports that last year, fund management fees, excluding expenses, dropped to just 1.4%.

Funds that trade in secondaries however are thriving. A Preqin survey found that nearly two-thirds of investors view secondaries as offering the best opportunities in private equity. Last year, fundraising in the secondaries market hit $91.2bn, three times that of 2022, with 70% of funds closing above target. So far this year, nearly $47bn has been raised in the secondaries market, accounting for more than a tenth of all private equity capital raised.

Whilst an influx of new capital is flowing into the secondary market because motivated sellers emerge, and buyers are seeking bargains, nevertheless closing deals remains challenging due to differing valuation expectations. The opaque nature of private capital contributes to this, with GPs having little incentive to mark down portfolio company prices in line with higher risk-free rates and lower equity markets. Meanwhile, prospective buyers are keen to revalue assets, leaving LPs caught in the middle, eager to exit but reluctant to accept deep discounts.

Manulife Investment Management suggests that LPs are holding out for pricing that meets their expectations. Unlike in previous market dislocations, where LPs were quicker to capitulate on price, often driven by distressed selling or structural factors, LPs in this cycle are exhibiting more patience. As the market recovers, market participants are likely to benefit from tighter bid-ask spreads, with traditional secondary investors becoming increasingly eager to deploy their dry powder.

Preqin highlight that the liquidity that secondaries bring to private markets comes at a cost of both time and money. For investors, secondaries provide a lower entry point, with average minimum commitments of $2.0mn compared to $14.1mn for traditional buyouts. They also offer manager and vintage diversification, outsourced due diligence, and a smoother return profile. In performance terms, secondaries compare well to direct private equity. In the longer-term, net IRRs by vintage year for the two strategies closely track each other. For more recent vintages (2016 onward), secondaries have higher IRRs, partly because the underlying assets are more mature and closer to realisation.

There is a certain circularity in the fact that the same firms raising capital to trade in secondaries are often the ones that raised the original funds in the first place, embodying Wall Street’s drive to profit from changing asset values, whether they’re rising or falling. In June, Goldman Sachs announced it had raised a record $3.4bn for its third real estate secondary fund, Vintage Real Estate Partners III—the largest fund of its kind in Wall Street’s history. This follows its predecessor, which closed in 2020, raising $2.8bn. StepStone is currently raising capital for its fifth real estate secondary fund and has already surpassed the $1.4bn raised for its previous fund in 2020. These new fundraising efforts come on the heels of Ares' successful close of $3.3bn for its Landmark Real Estate Fund IX in December, and Blackstone's completion of $2.6bn in November for its Strategic Partners Real Estate VIII fund.

Private real estate funds, from which these secondary funds may buy, now hold an estimated $393bn in net asset value (NAV), according to MSCI, which tracks private investments. This figure has risen by more than 70% over the past five years and represents the value of buildings and other investments after debt and fixed expenses have been deducted. Discounts are eroding though. In the first half of 2024, Pricing rose by 400 basis points from H2 2023, reaching 74% of NAV, according to Jefferies. This growth was primarily due to improved pricing for newer vintages and reputable GPs, particularly in assets with a data centre or industrial focus. However, highly concentrated funds and portfolios with material retail and office exposure continued to face meaningful discounts.

Investors and managers are increasingly seeking liquidity in today’s market, driving growth in both manager-led and investor-led deals. Continuation funds are also gaining traction among those willing to navigate their complexities. These funds offer investors the option to maintain existing exposure or gain entry to a mature portfolio of high-quality assets, while simultaneously addressing the liquidity needs of those looking to exit a fund nearing the end of its lifecycle. In this win-win scenario, managers are able to optimise asset performance and better align with investors’ objectives and business plans over an extended time horizon.

In StepStone’s Real Estate House Views published in Spring of this year, they suggest that GP-led secondaries are likely to see increased use as a tool for managing funding gaps and addressing LP liquidity needs. A significant portion of GP-led secondaries is bespoke and unreported, meaning much of the activity is not well captured in available data. StepStone also have stronger conviction in European secondaries which are supported by healthy fundamentals although they remain vulnerable to recession in certain parts of the region, which is likely to differentiate manager performance. NAVs have declined significantly, with UK and Nordic-focused funds adjusting the fastest. Unlike in the US, fund-level NAV adjustments to reflect new market pricing vary considerably across Europe. As a result, secondaries pricing in this region requires particularly careful underwriting.

Nuveen anticipates that volume in the secondaries market will increase due to the current low churn rate compared to other illiquid assets. With $15trn in assets under management across private markets, only $114bn in annual secondary volume exists, representing less than 1% turnover. Nuveen compares this to the US real estate market, where approximately 5% of homes are typically for sale, despite being a highly illiquid asset class. This suggests that private markets have significant room for growth in secondary transactions. As asset classes like private credit, which had only $4bn in secondary volume in 2023, begin to develop more active secondary markets, Nuveen expects higher churn and increased secondary market activity.

The 2023 Investec Secondaries Report survey indicates a greater use of leverage at the deal level for LP-led transactions (46%) compared to GP-led transactions (31%). This difference is expected, given that GP-led transactions are a relatively newer segment of the secondary market. However, 31% still represents a significant portion of secondary financing and highlights a growing trend. In recent years, Lloyds too has seen significant changes in financing terms. Loan-to-value (LTV) ratios, which softened after the global financial crisis, are now returning to their long-term average of 40-50% for diversified portfolios as market sentiment recovers. Direct PE NAV transactions, however, maintain lower LTVs of 5-20%, reflecting their higher risk. Lloyds emphasises that financing structures have evolved, focusing on supporting managers with strong track records and high-quality assets. The bank's global presence and deep market insights allow it to adapt to changing macroeconomic conditions and meet the evolving needs of secondary market participants.

During his research for his book “Secondhand: Travels in the New Global Garage Sale”, Adam Minter travelled across the world to places where secondhand goods are “collected, bought, repurposed, repaired, and sold.” Everywhere he went, he was overwhelmed by the sheer scale of unwanted items. Between 1967 and 2017, the amount Americans spent annually on things—ranging from sofas to smartphones—grew nearly twenty-fold. Minter’s well-researched study provides a truly global perspective on how old items can be given a new lease of life, and parenthetically how vintage funds can be revivified?with a new lease of life. Of note, Minter highlighted the dumping of American “e-waste” on less-developed countries. In many cases monitors, keyboards, desktops and laptops that developed countries consider as ‘e-waste’ can be repaired, often by cannibalizing parts from other used machines and exported back to the United States as new devices, “giving the rich man the opportunity to buy back his broken thing at a premium.” This pretty well captures what secondary investors are doing right now. Seems to us like people started Spring cleaning too early.