Turning Denominator Stress Into Liquidity: A Practical Guide To Real Estate Secondaries

What Has Changed and Why It Matters Now

Higher interest rates have reset both cap rates and the true cost of debt. Public markets repriced rapidly. Private real estate valuations adjusted more slowly. In that interim period, many institutions breached private allocation policy ranges as total plan assets declined while private NAVs lagged.

As a result, a significant number of LPs are managing two simultaneous requirements. First, returning to policy compliance within defined allocation corridors. Second, funding unfunded commitments across real estate, infrastructure, and buyouts.

For most institutions, the only scalable mechanism that advances both objectives is the secondary market, through a combination of LP-led sales and GP-led solutions. The strategic question is not whether secondaries have a role. It is how to deploy them deliberately, in a manner that restores flexibility at an acceptable effective cost of capital, rather than through forced selling.

How Pricing Works in LP Secondaries

Most real estate secondary transactions are priced off a stated reference NAV date, for example a purchase price equal to 90 percent of the June 30 NAV. Legal closing commonly occurs weeks or months later. Between the reference date and closing, the purchase price is adjusted to reflect interim fund activity.

Mechanically, the buyer begins with the agreed percentage of the reference NAV, then adds the seller’s share of capital calls made after the reference date, subtracts the seller’s share of distributions received after the reference date, and applies agreed adjustments for fees, expenses, FX, and carry or equalization mechanics. The result is the final cash consideration paid at closing.

Discounts to NAV are primarily driven by three factors. The first is stale NAV risk. If buyers expect valuation reductions between the reference date and closing, they widen discounts to protect against mark risk. The second is unfunded commitments. Positions with meaningful near-term call schedules typically trade at wider discounts, or require a negotiated form of unfunded relief. The third is timing and execution risk. GP consents, ROFR and ROFO mechanics, and slow transfer processes increase market movement risk. That uncertainty is reflected directly in pricing.

What Discounts Signal, and What They Do Not

Headline discounts are rarely a direct assessment of the GP as an institution. More often, they represent a composite price on the asset mix, leverage profile, and timing risk around exits and refinancings.

The variables that most directly influence pricing include asset fundamentals, debt profile, fund shape, and process quality. Asset fundamentals are largely defined by lease roll, tenant credit, capex intensity, and market rent growth. Debt profile is shaped by maturity wall timing, floating versus fixed exposure, hedge position, and covenant headroom. Fund shape reflects concentration, age, percent realized, and visibility into realizations. Process quality includes GP cooperation, consent predictability, and equalization complexity.

In the current rate regime, deeper haircuts are typically associated with assets facing refinance risk and heavy capex. Shallower discounts are more common where debt is termed out and hedged, assets are stabilized with limited near-term capex, and consents are expected to close efficiently.

LP-Led Versus GP-Led: Different Tools, Different Use Cases

LP-led transactions transfer an existing fund interest to a buyer who assumes the seller’s future capital calls, distributions, and reporting. The principal levers are auction design and buyer targeting, selection of the reference NAV date, treatment of unfunded commitments and any relief mechanics, and segmentation of positions into lots to manage concentration constraints. The principal frictions are GP consents, ROFR provisions, and transfer fees. LP-led sales are best suited for policy rebalancing, exiting non-core relationships, raising cash for near-term capital calls, and reducing commitment overhang.

GP-led transactions, including continuation vehicles, strip sales, and tender offers, typically involve moving a set of assets into a new vehicle. Existing LPs are offered a defined election, commonly to sell, roll, or in some cases contribute additional capital. Secondary bidders provide price tension and, in certain cases, incorporate stapled commitments. Deferred consideration can be used to bridge valuation gaps. Because conflicts are inherent, GP-led processes must meet a higher governance standard, generally including independent valuation support, fairness opinion support, and robust disclosure. GP-led tools are best suited for concentrated assets requiring additional time, capex, or refinancing runway beyond the current fund term.

What Secondary Buyers Underwrite

Secondary buyers underwrite fund interests on a look-through basis to the underlying asset business plans. Key focus areas include whether current appraisals fully reflect the prevailing rate regime, NOI trajectory with emphasis on lease expiries and mark-to-market potential, debt maturities and hedge expirations within the next 24 months, refinance outcomes under forward curves, spreads, and covenant constraints, and capex visibility and risk, particularly where TI and LC or retrofit requirements are material. Tax and structural considerations may also constrain the buyer universe, including REIT blockers, UBTI, and withholding.

In most cases, debt and near-term refinancing risk is the largest determinant of price.

Denominator Effect: Mechanics, Not Messaging

Most policy targets are expressed as ranges, for example 10 percent plus or minus 2 percent. When public markets decline, private real estate NAV can increase as a percentage of total plan assets before appraisal marks adjust. This is the denominator effect.

It typically creates three near-term pressures. Governance pressure emerges as committees debate waivers versus mandatory rebalancing. Pacing pressure emerges as DPI expectations prove optimistic and duration increases, reducing flexibility for new commitments. Liquidity pressure emerges as competing capital calls arrive across private market programs. In that context, real estate secondaries often represent a direct and scalable source of liquidity.

Execution Playbook for LP-Led Sales

A disciplined LP-led process begins with portfolio triage. Positions should be segmented by expected price and execution friction to prioritize what can be sold efficiently and avoid forcing difficult exposures into the market unnecessarily.

Objectives should then be defined explicitly. The relevant question is whether the priority is cash proceeds, unfunded relief, manager rationalization, or a combination. Objective clarity drives asset selection and structuring.

A defensible reference date should be selected. Quarters where marks are realistic generally lead to better outcomes than dates immediately preceding known events, write-downs, or refinancing outcomes.

A credible market process should then be executed. A focused buyer list, consistent information packages, and clear presentation of look-through debt schedules, hedge details, and capital needs are essential. Economic mechanics in documentation should receive equal attention, including interim flows, transfer fees, escrows for contingent claims, deferred consideration, and valuation adjustment language.

Finally, GP engagement and consent timing should be managed proactively. Early communication often reduces delay. Where feasible, omnibus consents can mitigate timeline risk. Equalization entries and fee mechanics should be tracked through closing to prevent avoidable value leakage.

How to Evaluate a GP-Led Continuation Proposal

Evaluation begins with asset selection. The critical question is whether the continuation vehicle is comprised of genuine winners with clear remaining upside, rather than assets being warehoused because they are difficult to sell.

Price formation should be scrutinized. Pricing anchored by third-party bids and independent marks merits greater weight than pricing determined primarily by sponsor modeling.

The economic structure should be reviewed in full. Carry crystallization versus reset, fee levels relative to the flagship, and demonstrable GP alignment through meaningful rollover are central. LP elections must be clear and economically comparable, allowing investors to sell or roll on equivalent terms. Finally, the proposal should include a credible three-to-five-year plan addressing capex, leasing, refinancing, and realistic exit windows. Without that plan, LPs assume duration risk without a sufficient roadmap.

Setting a Reservation Price

A discount can be translated into an implied effective cost of capital for liquidity and policy compliance. That is the appropriate lens for setting reservation prices.

The relevant comparison is not discount versus NAV in isolation. It is discount versus realistic alternatives, including raising short-term liquidity at higher cost, selling public holdings at disadvantageous levels, or curtailing commitments to strategically important programs.

Where fund fundamentals are strong and realizations are near-term, alternatives such as partial sales, permitted fund-level NAV financing, or structures with deferred consideration and upside sharing may warrant evaluation. The discipline is to make the trade-off explicit and intentional.

Common Errors That Reduce Outcomes

Execution outcomes are often impaired by repeated, avoidable errors. Selling off a reference date immediately ahead of anticipated markdowns is one. Underestimating the economic impact of unfunded commitments and near-term call schedules is another. Running a narrow or under-marketed process that fails to establish credible price discovery is a third.

Allowing consent and ROFR timelines to drift increases time risk and typically widens discounts. In GP-led transactions, accepting carry crystallization without compensating concessions on fees, price, or alignment can also result in avoidable economic leakage.

Buyer Segmentation and Why It Matters

Buyer type matters because different buyer categories price different exposures differently. Diversified secondary platforms tend to prefer scale, diversified funds, and clean execution. Real estate specialist secondaries underwrite deeper at the asset level and may pay more for portfolios with clear fundamental momentum, while requiring steeper discounts for complex or capex-intensive exposures. Insurers and structured capital providers can offer selectivity and, in certain cases, structured solutions such as deferred payments or preferred tranches.

Matching the buyer category to the relevant slice of the portfolio can improve pricing, reduce process risk, and increase certainty of close.

Practical Takeaway

Secondary sales should be approached as capital allocation decisions, not as reactive liquidity events. A disciplined approach begins with a defined liquidity target and an explicit view on unfunded relief, then applies the appropriate tool to each situation, whether LP-led sales, GP-led solutions, or structured transactions.

In the current market, process quality meaningfully influences outcomes. Reference date selection, interim flow mechanics, unfunded treatment, and timeline discipline around consents and ROFR provisions can shift realized pricing by a material margin. When preparation and execution are managed with rigor, the NAV discount becomes one input to a deliberate decision, not the defining outcome.