The natural impulse of investors to flee a commercial property market going through its worst period since the early 1990s has begun to test liquidity levels in certain UK funds.
There are worries that UK property funds will not have the cash to pay exiting investors, and will be unable to sell property fast enough in what is a tough transactional market to raise the money.
“There is clearly a mismatch between the illiquidity of the asset and the liquidity of the trust structure, which investors could find to their cost,” says Mike Prew, Lehman Bros property analyst.
This week, FT Money contacted every fund manager in the sector to gauge sentiment, and ask whether liquidity levels had reached a crisis point.
Reassuringly, none said there was any immediate danger of preventing investors from leaving – although many reported that they are now selling properties to ensure liquidity levels are maintained. Investor flows are now flat or negative in almost all funds.
Most admitted worries for the short term, particularly if investor sentiment continued to sour, but expressed hope that investors would stand by property as a long-term investment and an important portfolio diversifier. They also said the overall return this year will be flat, with a similar performance expected next year.
On the face of it, the market does not inspire confidence. In September there was the first monthly decline in total returns since 1992, with returns then sliding between 2 and 5 per cent in the last few months and forecast to continue to decline for anywhere between six to 24 months.
Closed-ended funds and property companies have experienced crashing net asset values, and even more disastrous share price performances. Shares in Real Estate Investment Trusts (Reits) have dropped some 38 per cent in the year to date, suggesting the market is pricing in further falls in asset values.
The performance of open- ended funds invested in property shares has been similarly dismal, but while they suffer by having to sell shares into a depressed market, at least they can raise cash to pay departing investors. The new worry is that open-ended funds invested directly in property will struggle with this.
To date, the bad news has all come from institutional funds. Last week, M&G said institutional investors in an offshore property fund would need to wait three months to exit, while Schroders put a similar time limit on a property trust and cut the value by more than 12 per cent. William Hill, head of property at Schroders, admits “the market has moved and there is nothing to be gained by us putting our heads in the sand and pretending otherwise”.
Charles Cade, analyst at Winterflood Securities, expects the investor exodus to continue and believes that the major retail funds could now also be forced to impose limits on redemptions.
To do so, funds would have to apply to the Financial Services Authority (FSA) for the right to defer payments, something that was last called on in the property sector by a residential fund run by Henderson in the early 1990s.
There are around 20 authorised property unit trusts easily available to the UK investor. The largest, run by Norwich Union, has seen liquid assets drop from 18.4 per cent at the end of July to 12.4 per cent at the end of October. The fund’s size has dropped from £4.1m to £3.6m.
Norwich Union would not comment on whether it would need to sell property, but others are less shy. Barry MacLennan, director at Standard Life Investments, says its fund has built up a healthy 28 per cent in liquid assets, partly through property sales since the summer.
Legal & General’s property trust has seen liquid assets drop from 19.2 per cent at the end of July to 17 per cent this week. But unlike most in the sector, Mike Barrie, director of fund management at L&G, says investor flows are still positive, although the last few weeks have seen redemptions rise. The fund has already sold property to maintain a “prudent” cover for exiting investors, he says.
The SWIP property trust has around 7 per cent in cash, down from 11.5 per cent at the end of July. A spokesperson says that it “has cash within the fund to meet redemption levels”.
New Star has sold some equities from its property trust, raising the cash position. The fund now allocates 15.2 per cent to shares, from 17.3 per cent at the end of July, and 9.5 per cent in cash, up from 7.8 per cent. There have been total redemptions of around 5 per cent since July.
M&G says flows have recently turned negative in its property fund, with daily withdrawals at around £1m last week, but adds there is a liquidity buffer of some £70m.
John Willcock, director at Threadneedle, would not comment on the exact level of liquidity within its fund, only saying it was “healthy”.
Jonathan Polin, a director at Resolution, says flows have turned “slightly negative” but stressed that overall redemptions had proved quite small so far.
Like most in the sector, Resolution’s fund moved to its “cancellation price” some time ago, he adds, which means that exiting investors receive the lowest possible unit price.
Polin says the fund has a liquidity level of around 10 per cent, which has been fairly static. He stresses that property is still a good investment in spite of the cyclical downturn.
MacLennan of Standard Life says predicts a “short, sharp shock”, rather than a sustained slump. “The sentiment is worse than reality at the moment,” he adds.
