It has been widely reported that Standard Life, Aviva Investors, M&G, Henderson, Canada Life and Columbia Threadneedle have taken the decision to freeze trading on their UK Real Estate Funds (and Aberdeen has introduced a dilution adjustment, meaning investors can redeem holdings but at a lower price). These are open-ended funds investing directly in physical commercial property in the UK. Perhaps unsurprisingly, each of the groups have cited the uncertainty created by the recent EU referendum as the main driver of these actions.
The move comes just days after a number of commercial property fund managers applied ‘market value adjusters’ to reduce the value of their holdings ahead of formal independent valuations. Because of the expectation among market participants and observers that valuations in the UK commercial property market will face downward pressure following the referendum result, fund managers are balancing the interests of shareholders who may leave the funds with the interests of those who remain.
Protecting the interests of all shareholders
The actions taken by these fund groups are squarely aimed at protecting the interests of all shareholders in the fund when there is lack of clarity over the pricing of property assets. Unlike listed shares or bonds, which are traded and have many holders, resulting in a fluid and transparent price-setting process, physical property assets – all of which are inherently unique – are illiquid and have a slower price discovery process.
When there are more sellers than buyers, this can prove problematic for funds owning physical assets such as offices or warehouses as it takes time (and transaction costs) to liquidate these in order to generate cash to return to shareholders who want out and a forced seller in uncertain market conditions is unlikely to achieve a great price.
This is why open-ended property funds hold large buffers of cash and other liquid assets. And here the current challenge predates the outcome of the EU referendum, as property funds have seen redemptions for some months meaning cash buffers will likely have declined ahead of the shock outcome of the referendum. That pattern of redemptions was undoubtedly fuelled by the uncertainty created by the referendum itself and the potential impact of a growth shock on occupancy rates. But it has also been down to widespread forecasts that irrespective of the referendum result a period of very strong capital appreciation seen in recent years has likely peaked with future returns much more anchored around rental yields.
Ambiguity – but not a collapse
The uncertainty around Brexit is undoubtedly a challenge for the property sector but this is not a post-Lehman Brothers style moment when the whole financial system faced collapse and the supply of credit – key to property transactions – was in doubt.
Following the referendum, we are now functioning in a period of ambiguity in relation to many factors that affect the property market. In the short term, there are likely to be more sellers than buyers, which will put further pressure on capital values until there is clarity on political leadership and medium-term prospects. Given the current market environment and increased uncertainty for valuations, most open-ended UK commercial property funds have moved from monthly to weekly valuations.
Understanding the full impact
The full impact for real-estate markets will depend on wider economy and monetary conditions. Specific real-estate factors and stress indicators which will continue to be monitored include: open-ended fund flows; market pricing adjustments; transaction volumes and pricing; REIT discounts to NAV; and signs of loan stress.
It is important to remember that investing in physical property funds requires investors to take a long-term buy-and-hold approach. Additionally, property funds shouldn’t be used as frequent trading vehicles.
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