Compared to conventional investments like stocks and bonds, alternative investment assets are typically characterized by a lack of liquidity and an expectation that they will be held until an exit event. When investors in these markets do require liquidity—and if they are actually allowed to sell—they are generally forced to offer their interests at a deep discount to an investment’s prevailing Net Asset Value (NAV). As research suggests, 10-30% discounts are common among many private equity secondary trades.1
If we accept the NAV as the true reference point for the price of an asset, does it make sense that these interests trade at such steep discounts? The answer should probably be no. But because of the general lack of transparency and volume in these markets, the discount is deemed necessary. Here’s why:
1. Transparency: When it comes to making investment decisions, public markets generally provide greater levels of transparency than private markets. Publicly traded investments offer investors multiple layers of data, including third-party research and company financials—giving investors the tools they need to make informed and confident decisions.
On the contrary, private markets traditionally don’t surface as much data for investors—there’s generally a lack of information about an asset’s performance, its financials, and data to support its NAV. If an investor is looking to assess a commercial real estate opportunity, finding data on market trends and comparable trades tends to be difficult. Additionally, an owner may not want to publish all data to the public, as it could attract unwanted scrutiny. This opacity can lead to discounts to essentially compensate potential buyers for the uncertainty in their purchase.
Opacity can also lead to information asymmetry, a particularly destabilizing dynamic for efficient markets. Whenever there is a lack of information parity between agents in a potential transaction, the agent with less information may have concerns about being fleeced by the agent with more information. In the context of private equity secondary trades, a potential buyer without equal information may be worried that the position they are buying might be a byproduct of adverse selection. Why is the seller exiting the position and what might they be hiding from me?
2. Volume: Private markets typically lack the necessary volume of buyers and sellers in secondary markets to allow for efficient price discovery. For example, if a large investor decides to sell a significant stake in a privately held asset on the Secondary Market, there may not be enough investors who are actively evaluating opportunities to buy the entire position. Conversely, since there’s little volume in the market, buyers may not want to spend the time and effort to evaluate an opportunity. Given this lack of competition in the market due to lack of liquidity, whenever a seller wants to exit an investment, the discount acts as an effective means to facilitate transactions.
How Cadre is building a more transparent and liquid marketplace
At Cadre, we’re committed to making private markets less opaque, which is why we created Cadre Secondary Market, a marketplace that lets investors buy and sell privately held real estate investments in a more transparent and liquid manner. We’re building pipelines to surface data to investors to help them make informed decisions about an asset’s performance—our quarterly reporting increasingly incorporates more data about the asset, from operational metrics such as cost per unit or physical occupancy, to market and submarket trends.
Our asset valuations are signed off by a third-party auditor semi-annually and fully audited once a year. Rather than burying assumptions within complex underwriting, we surface the key assumptions behind our go-forward projections to make it easy for investors to test and verify our expectations for themselves. Sellers on the Cadre Secondary Market leverage the same quarterly reporting data to make decisions that potential buyers do.
Cadre Secondary Market brings together buyers and sellers of commercial real estate to create a more liquid market where participants compete to transact. We understand that it is not the public market and for that reason, Cadre Secondary Market currently operates at a slight discount to the NAV, attracting potential buyers while allowing sellers to seamlessly gain liquidity in an otherwise historically illiquid asset class.
- Multiplicity Partners AG, “Private Equity and Secondary Market Pricing and Volume” Q1, 2019, https://www.mpag.com/wp-content/uploads/2019/03/MPAG_Insights_Q1_2019_Pricing_and_Volume.pdf