Primary concern: secondary trading
Of all the real estate professionals heading up the various INREV committees, there can be few that envy Peter Wittendorp and his team the task of investigating the issue of liquidity and secondary trading in the private real estate market.
Consequently, Wittendorp, a senior vice president with logistics manager Prologis is at pains to play down expectation: “Everyone is treating this a bit like the holy grail. Unfortunately, it’s my task to play everyone’s hopes down because there are a number of pitfalls involved with this area.”
He starts by comparing the highly regulated public share markets that have resulted from 150-200 years of stock exchange activity, with private, non-listed, negotiated real estate vehicles, to make the point. “I don’t have any illusions that people will suddenly be able to start trading partnership interests in private real estate funds, for example, because it takes a lot to do this.”
Firstly, he notes that discussion will have to take place with exchange authorities to start looking at the area and to see how investor interests can be safeguarded. “This is important because you can have a lot of parties involved.”
However, from the perspective of fund manager and investor members of INREV, Wittendorp says interest is high regarding the provision of liquidity and some kind of standard documentation and procedures through which managers and investors could engage to retain a more liquid market.
“This could only be a framework though. Within that you have to negotiate the transactions because that is what private markets are about, otherwise you are in the realm of liquidity of listed companies and I’m not sure if investors would feel comfortable themselves with this.”
Illiquidity in the private market means that assets, if traded, are done so at a discount. Wittendorp says it is up to fund managers and investors to make sure these discounts aren’t so wide.
He believes it is possible to get such a secondary framework for private funds, but points up the clear difference between a quoted vehicle where pricing is published, trading is transparent and sellers can wait to get the best price possible.
Such a framework for private funds, he says, would include arrangements on pricing, tax issues (private funds are highly structured) and disclosure; an important issue because many private fund deals are subject to strict confidentiality arrangements. But there is a range of other issues to be considered:
“How do you arrange clearing? What happens if you have a contract and all of a sudden the party you thought you sold your units to defaults on the contract. Do you go directly into litigation?
“There’s also the question of who buys the units from the investor. There may be a competitive issue where a fund manager could buy an interest in a fund to get hold of certain information.”
As such, Wittendorp describes the committee’s work as the “tip of the iceberg”. He says: “There are boatloads of issues that are coming in our direction, which is why we need to have legal and tax experts on board. For example, there are things like new accounting rules that could have an impact on valuation and settlement.”
The first phase of the committee’s work was to make an inventory of what is currently in the market in terms of liquidity provision, as Wittendorp explains: “Do funds offer voluntary or mandatory redemption features and under what conditions can this happen? “Also, does the fund manager have the obligation to take back units, which is moving to the more open-ended type of situation.”
The first step was to put out a survey to investors (pension funds and insurance companies) to see what they want on the liquidity side. Results from this are expected soon.
Wittendorp says there is demand from investors who would like the option of liquidity or redemption in order to trim portfolios to suit investment strategy.
“They might have a core real estate portfolio but also have a tactical portfolio where they want to take bets. If offices are out of favour and they want to do retail then they should be able to move a little bit.
“There may also be major redemptions on pension fund where there are no net contributions coming in any more and there is a need for liquidity. Or, if you’re an insurer that demutualises then the name of the game changes and you need liquidity.
“Most of the investors I’ve spoken to though don’t want to have full redemptions in any given year, but they at least want the option to consider doing that.”
The next step, he says, will be to gather fund managers together to get their input and survey them on their own feelings about liquidity provision.
Lessons could be learned from the private equity market, says Wittendorp, although he notes that the secondaries market in private equity is highly negotiated: “If you look at the bid/ask spread and the difference between what people carry in their books and what is executed, there is a huge discrepancy.
“This is fine and it will happen in property too. However, there may need to be more standardisation on property valuations. But there is generally good disclosure of what properties trade at, so it should be easier in some ways than private equity.”
By the summer the committee hopes to have an aggregation of the two surveys (investor and manager) to present to INREV members. After that, Wittendorp says the committee may have to split into sub committees to look at tax issues, valuations, settlement, legal issues and counter party risk. He suggests that while some of these problems may be difficult to overcome, INREV is tackling issues that the industry will have to look at sooner or later.
“This way the industry doesn’t get a tidal wave of liquidation issues.
“We will come up with a best practice overview and try to say what every fund should have in its documentation as far as these elements are concerned. Whether or not this gets adopted is up to the industry! We can look at supply and demand and make a recommendation, but we are not legislators.”