Property: is it too hot for the private equity players?

Just when it seems that the market has completely sunk into summer stagnation, up jumps a lovely big deal to keep lots of lawyers happy.

The much-talked-about public-to-private of Canary Wharf Group, estimated to be worth around £1.4bn, is just the thing to reignite the City in time for September, if not before (at the time of going to press, bids for the group were expected to have been submitted).

So far there are rum-oured to be four parties in the running for the property group: Morgan Stanley Real Estate Funds, Goldman Sachs' Whitehall Funds, Canadian real estate company Brascan and Canary Wharf's very own chief executive Paul Reichmann.

Last week law firms came over all shy when talking about which bidders they were representing. ("It's too sensitive," bleated one quivering little flower.)

It wouldn't be surprising to see Clifford Chance acting for long-time client and new landlord Canary Wharf and Freshfields Bruckhaus Deringer advising Morgan Stanley. Also, Sullivan & Cromwell client Goldman Sachs could ask Linklaters to reprise its role as UK counsel for its property fund. But that's just a guess.

Anyway, aside from the fact that this is a big deal in a quiet period, what is interesting about the transaction is the bidders themselves. I'm certainly not alone in being surprised by the fact that so far there has not been any interest from the private equity community.

One answer to this may be that Canary Wharf is already highly geared. In a typical private equity structure there is often a high degree of debt - the possibility is that with Canary Wharf there would be a requirement for a larger injection of equity than many would feel comfortable with.

But it is certainly not outside the realms of possibility to see a private equity house sniffing around a property-based company, although admittedly, real estate has mainly been a staple of the US-based private equity funds.

Well-known houses such as Blackstone Group and Apollo Management both have dedicated property funds, and in recent years, especially in the latter firm's case, have been quite prolific in investing in European real estate.

Importantly, many deals have not just been a case of buying up a load of buildings, they have been about investing in the operating company.

GE Capital's and Hermes' £1.9bn take private of MEPC in 2000, the largest such deal involving a property group (unless a Canary Wharf bidder starts getting silly with their chequebook), is testament to this fact.

Also, in recent years the classic private equity structure - using a newco in which management and a private equity house hold stakes - has been employed when investing in the property sector. Combined with this is a fertile market: in the past three to four years, at least 20 property companies have exited from the stock market.

An example of both these factors was last year's £167.6m buyout of Grantchester Holdings, which was acquired through newco Dundonald Holdings.

Here, 75 per cent of the business was taken by Scottish private equity group West Coast Capital and the Bank of Scotland, while the company's managers held the remaining stake.

So there is patently a market there, but it is something that many of our own larger UK private equity houses have chosen to ignore, specifically the option of having a dedicated fund solely for real estate.

To date only Doughty Hanson has a real estate fund, after it first announced that it would be courting investors for this sector way back in 1999.

Why others such as CVC, Cinven and Apax Partners have not chosen to raise a property-specific fund is not clear. One lawyer speculates that property can be "clunky and difficult to offload", although he counters this by saying that the returns can be very worthwhile.

It is not as though UK private equity houses are completely unaware of the potential merits of investing in property. A huge number of deals spawned from the ripe leisure and retail sectors in the past 18 months have had a significant property element to them, for example Permira's £700m buyout of Travelodge and Little Chef last year and the buyers who are currently circling for Scottish & Newcastle's pub and hotel estate.

Also, private equity investors have not been afraid to maximise their property assets, putting in place sale and leaseback arrangements.

But perhaps this is as close as larger UK private equity houses want to be to property. Ironically, it is the lawyers themselves who are being proactive, saying that they are certainly beginning to see real synergies between real estate and private equity.

Only a year ago Clifford Chance set up the real estate fund and investment banking group, headed by partner Robert Porter, to bridge these two practices.

Property partners at Freshfields, which has built up a strong reputation in private equity/real estate, especially in Germany (helped by Bruckhaus's sturdy pre-merger reputation), say that they found themselves working much more closely with corporate.

And at US firms such as Gibson Dunn & Crutcher's property group, headed by partner Alan Samson, there have been huge numbers of opportunities of cross-practice pollination. But it does seem that this is really being driven by US investors.

While UK lawyers do expect that local private houses will make the leap into property-based funds, they are not holding their collective breath. Which is probably just as well. But for the private equity houses themselves, it may be a while before the cycle brings round such an opportunistic market again.

dearbail.jordan@thelawyer.com