Landmark: the critical aspects of a fund restructuring

This article is sponsored by Landmark Partners and first appeared in the March issue of sister publication Private Equity International.

Fund restructuring is hitting a stride within secondaries. While traditional secondaries transaction volume across all strategies has grown at about 15 percent annually since 2013, fund restructuring transaction volume has boomed, growing over 60 percent annually since 2013.

In 2012, Landmark Partners participated in one of the first private equity fund restructurings; since then, fund restructurings have grown exponentially in volume, becoming an integral part of the broader secondaries market. And while “market defined” fund restructurings as they are known today only started to take shape in real estate over the last three years, Landmark has been involved in real estate GP-leds for some time. Landmark Partners closed the market’s two largest real estate fund recapitalisations over the last three years.

We asked Jamie Sunday, a partner in Landmark’s real estate group, and Ian Charles, a partner in Landmark’s private equity group, to explain the firm’s approach.

What does Landmark look for in a GP-led secondaries opportunity and how are potential deals identified?

Jamie Sunday and Ian Charles: Landmark is increasingly focused on the quality of the GP that we partner with and why that firm is pursuing the transaction. We always ask: is this a well-regarded firm with strong talent? Can the firm withstand, and execute within, a difficult macroeconomic environment? Who within the firm will be responsible for executing the investment thesis? Assuming we identify a great potential partner, we then focus on the firm’s incentives and motivations, asking: why does this transaction make sense for the GP, for the existing LPs and for the new liquidity provider? If the answers are not obvious and easy to explain, then the transaction does not make sense for us. This emphasis on quality GPs applies to both private equity and real estate secondaries.

In real estate GP-led transactions, we also look for well-seasoned funds that have quality assets remaining. We have been the most successful when our strong understanding of the assets or our ability to structure a creative solution for a high-quality GP puts us in an advantaged position.

What issues does Landmark look to solve for GP and LPs in these types of deals?

JS and IC: This depends on the circumstances. For the recapitalisation of a mature fund that has exceeded its legal term limit, Landmark typically looks to: a) provide an efficient liquidity solution for LPs looking to exit the vehicle; b) provide enough time and/or capital for the GP to execute its business plan and harvest remaining assets; and c) ensure strong alignment of interests.

What are potential hurdles that arise during a GP-led process and how are they overcome?

JS and IC: Three critical aspects of a GP-led process are:

1. Making a “status quo” option available to existing LPs in the fund

2. Maximum transparency around the assets, incentives and potential outcomes

3. A commercially reasonable timeframe for investors to evaluate the liquidity option and analyse available information

Landmark has recently invested in high-profile single-asset GP-led restructurings. What is attractive about these deals? How is concentration risk addressed in these deals?

JS and IC: Landmark is fortunate to have some of the largest, most sophisticated investors in the world as LPs in our secondaries funds. Many of these groups invest alongside us as co-investors in concentrated deals. Our most recent private equity and real estate secondaries funds closed in 2018 and have already generated about $4 billion in secondaries co-investment opportunities.

What is the potential for GP-led restructurings in real estate and real assets?

JS and IC: Over $2.1 billion, or 41 percent, of real estate secondaries transaction volume originated from fund sponsors in 2018, according to research led by our team of 17 dedicated real estate investment professionals. This is a substantial increase over the $1.4 billion of volume achieved in 2017. This growth can be attributed to the aging of “peak” vintage funds raised from 2006 to 2008. While many of these funds have reached or exceeded their initial legal termination dates, a substantial portion remain unresolved.

The fund restructuring opportunity in real assets is larger than in real estate and it could surpass more than $10 billion per year in the next five years. The asset concentration and duration mismatch of attractive assets in infrastructure and natural resources are staggering. Landmark is currently evaluating two real asset fund restructurings that represent over $6 billion in total transaction value. The biggest gating item for real asset secondaries growth is available buyer capital. Landmark remains one of few institutional buyers in both the real estate and real assets secondaries markets today.

What do you anticipate for the future of GP-led deals?

JS and IC: The fund restructuring market has potential to outstrip traditional secondaries transactions in private equity as early as 2020. The two most important variables are the pricing environment and fund restructuring deal performance. These transactions require fair and full prices to gain momentum and support from existing LPs in the fund. If secondaries pricing falls by 10 percent or 15 percent, volume in this part of the market will quickly collapse until more attractive pricing is available. If deal performance doesn’t meet expectations and buyers believe they can earn similar or better returns in more diversified portfolio opportunities, investors will rotate their capital to the buyers with a proven strategy and more attractive risk/return propositions. If secondaries pricing remains elevated and fund restructuring deal performance meets or exceeds expectations, we wouldn’t be surprised if the fund restructuring market is larger than the volume of traditional secondaries transactions within three years. The implications of this potential change in market structure are significant for everyone in the asset class.

Recapitalising a real estate opportunity fund
Landmark runs through the ins and outs of one of its recent fund recapitalisations

In 2017 Landmark Partners recapitalised a 2007-vintage global real estate opportunity fund (“the Fund”) and various affiliated co-investment vehicles. The Fund had successfully liquidated some investments from 2014 to 2017, but still owned a handful assets, including a logistics platform. The remaining assets were expected to need an additional three to five years to fully liquidate and the Fund was approaching its final extension option. Landmark was an existing LP in the Fund and had several conversations with the GP to explore alternatives. After working with the Fund’s advisory committee, the GP engaged an advisor to run a limited process with a select potential buyers.

Challenges

The transaction was structured as an asset sale, where the remaining assets were sold to a newly-formed vehicle to be managed by the original GP. This allowed the GP to efficiently wind down the existing fund. Asset sales are often encumbered by structural and tax complexities, which can lead to a longer process. This transaction took nearly 12 months to close.

Successes

The transaction had a very strong approval rate – over 90 percent of LPs provided consent. Approximately 60 percent of LPs (by remaining NAV) decided to sell and 40 percent decided to roll into the new vehicle. This participation ratio is consistent with the ratio seen in private equity fund restructurings. Overall, this transaction provided LPs with a liquidity option and gave the GP adequate runway to carry out its business plans and liquidate the remaining assets in a prudent manner.