A second chance

As the private equity real estate industry picks up in Europe, will the secondary market continue to remain in the shadows? By Robin Marriott

Secondary. The very word conjures up the image of something inferior. At the very least, it certainly doesn't sound like the kind of business worth investing in. Yet behind the scenes of the European private equity real estate industry, such a business exists. And the secondary market, in which limited partners sell their commitments in non-listed real estate vehicles, is quietly picking up steam.

Last month, for example, US secondaries specialist Liquid Realty announced that it had acquired an interest in a pan-European, value-added fund, the latest instance of activity in Europe's burgeoning secondary real estate industry. At €62 million ($82 million), the deal fell well short of Liquid's blockbuster last year, in which the US firm purchased interests in ten different UK Jersey Property Unit Trusts for £435 million. But it has at least served as a reminder to the outside world that the market is alive and well.

Jeffrey Giller, a managing principal at Liquid, says there are many reasons why an investor in a pan-European market would want to exit their private equity real estate commitments. In a rising market, sales are unlikely to have much to do with market performance, but rather with portfolio management needs. Sales could be precipitated by regulatory changes, for example, or when a pension fund finds itself overweight in real estate because of the decline in equities.

It certainly seems natural to expect total secondary volumes in Europe to rise. Yet there are also reasons to suspect that the market's growth will not be as rapid, or as robust, as some suggest.

Yet another reason that the market may take off is a geographic reallocation of institutional capital, says Ronald Dickerman, founder of another US secondaries buyer, Madison International Realty. As European institutions look to move capital into Asia, for example, they may need to sell off existing commitments in order to generate the liquidity necessary to reallocate their portfolio overseas.

“We absolutely see that trend in the market,” Dickerman says. “Real estate investors are thinking globally, but are constrained by the illiquidity of their legacy investment decisions. We see this trend in the US, UK, Netherlands, Germany, et cetera.”

Given the limited role that secondary transactions have had in the past, publicity may also help spur the market. Giller says Liquid's latest deal shows that secondary sales are becoming an “increasingly viable tool” for investors to exercise their portfolio management.

The universe of secondary buyers is also expanding. In addition to Liquid Realty, Landmark Partners is an active secondary buyer, as is Credit Suisse. Madison International is a newcomer to the market as well. And then there are LPs such as ABP, who are also willing to purchase secondary interests from other institutions.

Finally, INREV is contributing to the cause with guidelines for a secondary market that help address issues regarding valuation, transparency and sellers' rights.

Given all this, and the fact that more capital continues to be invested in unlisted property vehicles, it certainly seems natural to expect total secondary volumes in Europe to rise. Yet there are also reasons to suspect that the market's growth will not be as rapid, or as robust, as some suggest.

First, the European private equity real estate market is still in its earliest stages. Patrick Kanters, a managing director at ABP Investments, points out, a lot of European investors are still in the process of “building their portfolio,” which limits the need to sell off their real estate commitments. Second, the market is still relatively obscure even in a more mature property market like the US. Few deals there, for example, have even approached the size of Liquid's UK purchase last year. And finally, there is evidence from the private equity sector that secondaries will never be a major part of the overall industry. Though growth of the European LBO secondaries market has been steady, it still only accounts for between 1 and 3 percent of primary fund commitments each year.

What does that tell us? Well, for one, don't expect to see an explosion of interest in secondary transactions anytime soon. Growth, when it does come, is likely to come slowly and steadily.

In other words, the secondary market is still relatively young. It is set to remain in the shadows for a good deal longer.