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.
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:
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?
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 ↩︎
The views expressed above are presented only for educational and informational purposes and are subject to change in the future. No specific securities or services are being promoted or offered herein.
This communication is not to be construed as investment, tax, or legal advice in relation to the relevant subject matter; investors must seek their own legal or other professional advice.
Performance Not Guaranteed
Past performance is no guarantee of future results. Any historical returns, expected returns, or probability projections are not guaranteed and may not reflect actual future performance.
Risk of Loss
All securities involve a high degree of risk and may result in partial or total loss of your investment.
Liquidity Not Guaranteed
Investments offered by Cadre are illiquid and there is never any guarantee that you will be able to exit your investments on the Secondary Market or at what price an exit (if any) will be achieved.
Not a Public Exchange
The Cadre Secondary Market is NOT a stock exchange or public securities exchange, there is no guarantee of liquidity and no guarantee that the Cadre Secondary Market will continue to operate or remain available to investors.
Opportunity Zones Disclosure
Any discussion regarding “Opportunity Zones” — including the viability of recycling proceeds from a sale or buyout — is based on advice received regarding the interpretation of provisions of the Tax Cut and Jobs Act of 2017 (the “Jobs Act”) and relevant guidances, including, among other things, two sets of proposed regulations and the final regulations issued by the IRS and Treasury Department in December of 2019. A number of unanswered questions still exist and various uncertainties remain as to the interpretation of the Jobs Act and the rules related to Opportunity Zones investments. We cannot predict what impact, if any, additional guidance, including future legislation, administrative rulings, or court decisions will have and there is risk that any investment marketed as an Opportunity Zone investment will not qualify for, and investors will not realize the benefits they expect from, an Opportunity Zone investment. We also cannot guarantee any specific benefit or outcome of any investment made in reliance upon the above.
Cadre makes no representations, express or implied, regarding the accuracy or completeness of this information, and the reader accepts all risks in relying on the above information for any purpose whatsoever. Any actual transactions described herein are for illustrative purposes only and, unless otherwise stated in the presentation, are presented as of underwriting and may not be indicative of actual performance. Transactions presented may have been selected based on a number of factors such as asset type, geography, or transaction date, among others. Certain information presented or relied upon in this presentation may have been obtained from third-party sources believed to be reliable, however, we do not guarantee the accuracy, completeness or fairness of the information presented.