Property fund lock-in a scary sign of the times

The prospect of lower demand for commercial property, particularly in London, fuelled a wave of redemption requests. Picture: Leon Neal/Getty
The prospect of lower demand for commercial property, particularly in London, fuelled a wave of redemption requests. Picture: Leon Neal/Getty
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Investors will be vigilant for signs of further contagion this week after property funds with more than £15 billion of holdings moved to prevent people from withdrawing their cash.

Trading has been suspended by several open-ended property funds amid concerns over the impact on the market of the EU referendum outcome.

Experts say there’s no reason to panic and emphasise that property should be viewed as a long-term investment offering valuable diversification and income. But investors will be worried now that the measures taken over the past week could reflect deeper underlying problems.

Standard Life, Aberdeen Asset Management, Columbia Threadneedle, Henderson, Canada Life, M&G and Aviva have all imposed restrictions on investors wanting to sell out.

Trading on the £2.7 billion Standard Life Investments UK real estate fund (and its associated feeder funds) has been suspended for at least 28 days.

It said that “the decision was taken following an increase in redemption requests as a result of uncertainty for the UK commercial real estate market following the EU referendum result”.

The suspension of trading means investors are unable to redeem their shares. Fund groups say the aim is to protect investors who remain in the funds from the effect that a large volume of redemptions would have on the price. But for many it will be an uncomfortable reminder of 2008, when a number of funds closed to redemptions shortly before commercial property prices crashed.

While the trigger on this occasion was the uncertainty created by the vote to leave the EU, some of the underlying issues are similar. One is that while open-ended commercial property funds invest most of their money in illiquid assets (those that can be difficult to sell), they are priced on a daily basis.

Simon Lloyd, chief investment officer at Murray Asset Management in Edinburgh, believes the suspensions reflect this limitation of open-ended funds, rather than any expectations of a collapse in property prices.

Lower property demand is likely in the wake of the referendum, especially in London. That means many investors have decided to sell out of the sector and take their profits. To do so they have to redeem their units or shares with the manager of the fund, and the cash they are paid comes from the fund.

“In normal circumstances this liquidity requirement is managed by keeping a cash float in the fund but when the demand to redeem is overwhelming, cash will quickly be used up and the manager may be required to sell a property to provide the necessary cash for redemptions,” explained Lloyd. “This process can take many months and as a result, until the sale completes, the manager will be unable to meet redemption requests.”

Investors in the locked funds could face a wait of several months before they can access their cash, with uncertainty over the UK political climate as well as the longer term implications of the referendum.

At the time of going to press, the open-ended UK property funds run by Kames, Legal & General and F&C were still allowing trading, although all three have reduced their value between 5 and 15 per cent.

It’s unclear how well investors understand the downsides of the open-ended structure and fund firms have been criticised in the past for failing to make them clear.

The alternative is closed-ended vehicles such as investment trusts, which don’t have to sell assets to cover redemptions. Instead investors wanting to withdraw have to sell their holdings on the open market, although share prices have fallen since the EU referendum.

“Share prices in the closed-ended funds listed on the stock exchange have fallen, but the seller has received a payment for their shares and the buyer will purchase the shares at a discount to the net asset value,” said Lloyd. “At no point in this transaction has the manager of the fund had to provide liquidity, an owner of the shares has simply sold their shares to a new owner.”

So what does all this mean for the wider market? Can investors expect a repeat of the rapid contagion of 2008, when banks were hit hard by the commercial property downturn?

Lloyd believes the present situation is less serious than it was eight years ago, when the banks were in serious difficulties and no longer lending.

“We do not see the same conditions at the moment,” he said, pointing to factors such as banks being less exposed to property and having increased their capital levels.

“It seems unlikely that a fall in property prices will be avoided but if a recession is avoided and rental demand remains relatively healthy, the impact should not be as extensive as it was eight years ago,” said Lloyd.

Others concur, and urge long-term investors to be patient.

“Selling out when prices have fallen sharply is usually a bad idea, particularly if the decision is a knee-jerk reaction,” said Laith Khalaf, senior analyst at Hargreaves Lansdown.

“The fundamental trends that 
led to the popularity of property as an asset class are still in place, with interest rates still low and gilt prices still high. Economic uncertainty casts a shadow over the sector for sure, but as yet we lack real data 
on what the full impact of Brexit 
will be.”

Commercial property is attractive largely because of the income it 
pays and the diversification it provides (due to its low correlation with other asset classes). That’s what long-term investors should continue to focus on, but they also need to be aware of the shortcomings of the sector.

“Investors in property funds need to focus on the reasons they bought commercial property in the first place, and consider whether they are still intact, because there may be challenging times ahead,” said Khalaf.

“High costs and poor liquidity are two drawbacks which investors need to be willing to shoulder before investing in the sector.”