Three major UK real-estate funds suspended trading in their shares this week in an attempt to stem the wave of withdrawals that followed Britain’s decision to leave the European Union. Standard Life Investments put a halt to trading on its £2.9bn commercial property fund on Tuesday, followed closely by M&G’s £4.4bn Property Portfolio (the largest in the sector), and Aviva Investments’ £1.8bn UK Property Trust.
The suspensions mean that existing investors in the funds will be unable to withdraw their cash until trading resumes, which illustrates a fundamental problem with these kinds of property funds. When an investor pulls money out of an open-end fund, the fund manager initially aims to meet the redemptions out of the cash reserves that most funds always maintain. However, a rush of investor redemptions can quickly eat into these reserves, meaning the fund manager may be forced to sell off part of the portfolio to raise more cash.
For a fund that invests in liquid assets such as shares and bonds, this is usually not too difficult, but obviously selling an office block or warehouse takes longer. And the more that managers are pushed to sell holdings fast in order to meet redemptions, the more they may have to rush into unfavourable deals, which will hurt investors who continue to hold the fund.
Hence a rush of withdrawals can spook other investors and encourage them to follow suit out of concern that if they hang on, they run the risk of getting less of their money back than those who are first out the door. By halting trading in the funds, the managers are attempting to prevent this vicious cycle of panic selling and forced asset sales.
Shaky foundations
These suspensions should come as no surprise. The UK’s commercial property sector has shown signs of weakening for a while, and investors were clearly getting nervous in the run-up to the EU referendum: property funds saw net outflows of £500m in April and May of this year, according to data from the Investment Association, the funds industry’s trade body.
Now the result of the referendum has led to growing concerns about the economic outlook and about the attractiveness of the UK as an investment destination (foreign investors play a major role in the London commercial property market). Hence the sudden spike in investors pulling their cash out of commercial property funds.
The outlook for the market may not be as bad as some investors expect. Fears of a repeat of 2009 – when prices slumped during the global finance crisis – are overdone, according to Eduardo Gorab of Capital Economics. Lower supply of new properties should lessen the impact of any shortfall in demand. Meanwhile, the fall in sterling might even tempt foreign investors, since UK property is now cheaper in foreign-currency terms.
However, the fund suspensions may be a blow for a sector that has struggled to regain investors’ trust after similar trading halts during the global financial crisis. We think that wouldn’t be a bad outcome. Commercial property can be a good source of income at a time of low interest rates, but holding an illiquid asset in an open-ended fund that lets investors redeem shares on demand is asking for trouble. That’s why MoneyWeek favours listed funds, such as real-estate investment trusts (Reits). These vehicles are listed on the stock exchange, so investors can sell whenever they want without the manager having to raise cash to pay them back.
Obviously, investors are not guaranteed to get back as much as they put in. And because the price of the fund can move independently of the value of the underlying assets, these funds can trade at big discounts during market turmoil. So anybody panicked into selling may get a poor price – but at least they won’t be locked up in the fund until the manager decides that it’s safe to resume trading.