Secondary market trading portal PropertyMatch is -expanding into continental Europe, but given that the region is dominated by closed-end funds and that trading is much more complex, what scope is there for this instrument of liquidity? After all, a closed end fund is exactly that - closed. Christine Senior reports

A deep divide exists between the markets for secondary trading of unlisted real estate funds in the UK and in continental Europe. The UK market has traditionally been more geared up to trading the funds, whose structures allow investors to move in and out quite freely. In continental Europe private equity-style vehicles predominate, and they are less flexible and more difficult to trade.

UK funds structured as Jersey property unit trusts put up few barriers to sellers who want to buy or sell units, no consent from the manager is needed, and the documentation and procedures for the transfer of ownership are relatively straightforward. Funds have tended to be perpetual or long-life funds and open-ended vehicles. And in the past when the market involved predominantly core funds with monthly valuations, pricing could be expected to closely track NAV.

By contrast, in continental Europe there are more funds at the value-add and opportunistic end of the spectrum. They hold assets that are more difficult to value, with less frequent valuations. For a fund's limited lifespan of usually between five and seven years, investors generally expect to hold their commitments to the fund's maturity.

In this scenario a secondary market is more problematic: the general partner's agreement is necessary for a transfer of holdings and even essential for buyers to get access to all the information they need to agree a price. The key concern is to ascertain an accurate valuation - not an easy task for funds that are valued once a year with some opaqueness on their underlying assets.

In the UK, an informal trade in units has worked relatively well through word of mouth, but lacks the efficiency of a formal arrangement. The market is small enough for news of units up for sale to get round on the grapevine, with deals concluded on the back of that, often between existing investors in the fund.

"When you break it down, this is a small industry with a small number of players, and all know each other. That's a good and a bad thing. If you want to trade anonymously, that's an issue," says Nick Cooper, head of Townsend's discretionary business and recently appointed chairman of AREF's investor committee.

Managers themselves have been willing to act as brokers for buying and selling units in their own funds as a service to investors. Schroders provide this service, taking a brokerage fee for it. John Harding, product manager in Schroders' UK property product team, thinks this works well for the manager by making the funds themselves more attractive to investors, because of the inherent liquidity that introduces.

"We think it's good practice as a fund manager," he says. "Investors will see our funds are more attractive because they see some form of liquidity in illiquid assets. We do a matched bargain trading service, bringing buyers and sellers together anonymously. But it takes time and resources to get someone interested, and give them information so they can properly underwrite the value of an asset."

In the rest of Europe trading is much more complex. Julian Schiller, director at Jones Lang LaSalle (JLL) Corporate Finance, says: "Outside the UK it is an intermediated marketplace where to give information to a potential buyer, often confidentiality needs to be put in place, you need to provide information, you need to arrange conference calls with the management team of the fund so the investor can get comfortable both with the manager and the fund itself. It can take many months for someone to conduct diligence on the fund and undertake their analysis."

He says in continental Europe a typical transaction will take four to six weeks as a minimum, but could easily take up to five months.

JLL estimates that the secondary market was worth $3.5bn (€2.37bn) in 2010, with around $1.5bn of that in UK-focused funds, and mostly between UK investors. JLL itself brokered over 40 transactions, to the value of €274m - predominantly UK deals. Indicative prices last year for core funds were up to 15% discount to NAV, valued-add up to -35%, while opportunity funds were at 20% to 60% discounts.

Trading portal PropertyMatch reports a big increase in activity over the 15 months of its life. "Initially we were doing one or two trades a month. Now it's double digits," says Michael Levi at CB Richard Ellis, which in a joint venture with GFI, runs PropertyMatch.
PropertyMatch is planning to extend its range to cover European deals, where it's more difficult for buyers and sellers to link up.

Levi adds: "The UK market used to manage somehow in a rough and ready way to find opposite interest out there. In Europe it's so disparate and motley that it's difficult to know what people want to do. We are about to establish PropertyMatch in Europe and list some of the vehicles in Europe on the screen. Everybody is desperate for some assistance to bring about liquidity and rid themselves of the opaqueness of their market. That's where our focus lies going forward."

More recent newcomer Indirex differs from PropertyMatch in acting purely as a data and information portal for UK and continental European unlisted real estate funds, and not a trading board. It provides a single point for locating generic information about funds, alongside performance data. Additionally, there are secure data rooms, not open to all, which allow buyers and sellers to do their due diligence on funds and get the relevant documentation, rather than having to go to the fund manager.

Currently there is far more information about UK funds than continental European ones, but Gary McNamara, Indirex's managing director, hopes to expand the coverage of European funds over time.

Indirex can also act as a passive bulletin board to put buyers and sellers in touch.
"If somebody wants to list what they are holding or something they may like to buy, they can list that passively," says McNamara. "We are making sure people can get in contact with each other using the system, as opposed to us doing the introduction or broking."

In spite of the increase in sources of information and ways to trade, barriers to trading private equity style funds remain significant. Opportunistic funds are always going to present difficulties in trading because of their structure. Yearly valuations make pricing difficult. But in the downturn, liquidity in these funds became a big issue as more investors faced difficulties and needed an exit. In closed-ended funds sellers were forced to accept huge discounts to NAV to exit the funds or, in some cases, had to pay a premium to leave.

Have platforms such as Indirex and PropertyMatch helped open up the secondary market for these funds? Deborah Lloyd, partner in the funds and indirect real estate team at Nabarro, says they have had limited help. "I think they have helped with transparency and data and information. They're not the perfect answer because the whole nature of closed-ended funds is they are not built for trading."

Another gain from the portals has been anonymity. Cooper welcomes the arrival of Property-Match and Indirex for that reason: "The more you can add anonymity the more investors will be encouraged to use the secondary market."

But in continental Europe where even the definition of NAV is not standardised, more radical changes are needed before a transparent and liquid secondary market can develop. Harding welcomes the service that portals provide as a means of getting a more accurate valuation, but says it falls short of what is really needed: "You can look at a website, identify some price discovery in what the last trade was, see what someone may be asking or willing to sell at but when it finally comes to doing the deal you still have to pick up the phone, you still have to underwrite the value of these assets, determine whether this is fair market value, and then come up with terms on the trade. That is what I see as the biggest challenge."

In any case, trading portals for the secondary market might face some opposition in Europe. Managers might not welcome any form of platform that could compete with the service they offer, says Harding.

"A lot of managers that specialise in secondaries don't really want trading platforms out there because a trading platform will offer price discovery, whereas these groups spend a lot of time building from the bottom-up models that analyse the value," he says. "That differentiates them from other groups and they are able to charge underlying clients a fee for that. So it's attacking their business. They believe they have better information than the market and, as a result, are able to get better pricing."

Other efforts to facilitate the secondary market are coming from INREV. The organisation is working towards encouraging more transparency as a step towards attracting more investors.

As chair of INREV's secondary markets and liquidity committee, Mike Clarke, senior managing director and head of European real estate at Mesirow Financial, is involved in an initiative to standardise language used in documentation of funds to increase liquidity and transparency in secondary funds: "In the work I do with INREV, we are trying to increase the transparency of net asset value and the reporting of the funds. If managers do that, it will make it easier for investors to buy and sell on the secondary market because it will be easier to evaluate the underlying investments."

INREV is also considering providing a bulletin board to be put at the disposal of members to indicate if they have stock for sale or stock they want to buy. But before this can be launched, some issues, such as regulatory restrictions on marketing private funds, need to be addressed.

Trading and settlement as it happens in the equity market is a long way off in the real estate market. T+10 is the usual term for closing the deal, and that 10 days is necessary to complete the administration and paperwork.

"You know if you buy a share it settles in three days. Here in the secondary funds market it may settle in 10 days, and you need 10 days to do the paperwork to make sure all the groups are talking to each other," says Cooper. "The process of administration of our custodian talking to their custodian to make sure all the papers are in place and all the know-your-customer information, which we know has to be done, is a nightmare. You begin to think: was it worth it?"

Improvements in this paperwork are already under way. Melville Rodrigues, a partner at CMS Cameron McKenna, has developed standardised secondary trade documentation that can be used by both sellers and buyers.

Rodrigues says: "We should be focusing on solutions which will improve liquidity and other elements which can bring more confidence to the market. For instance, when investors negotiate a trade, typically on a T+10 basis, all relevant conditions must be efficiently satisfied so that the trade closes on the tenth day - and the seller is then in receipt of the purchase monies and the buyer has title to the units."

But Rodrigues feels managers could do more to help smooth the way: "Managers can also facilitate the process, given their leverage with administrators. This would encourage more investors to participate in secondary trades, and address some investor liquidity management concerns when considering unlisted funds."

For all the efforts to facilitate more liquidity and a more active market in Europe, it may be that the demand for it among investors is not there. Schiller is not so sure that investors necessarily want a rapidly trading market: "European funds are usually structured as five- to eight-year vehicles. Investors are going in knowing they are undertaking a business plan and they will get out in five to eight years. They see the termination of the fund as their liquidity. It's fair to say some do want some liquidity and like the idea of the secondary market but the majority of vehicles in Europe are closed-ended. There is a different mindset among investors investing outside the UK."

Nevertheless, Schiller does expect the European market to develop more over time: "There is definitely an increased desire for more transparency to allow this market to develop. But I wouldn't say there is a huge industry move to get us there at the moment."