Property funds better placed to weather storm than in 2007
‘This is not a Lehman Brothers moment,’ says one fund manager
When three funds holding £9bn of investors’ money halted trading this week, it brought back memories of the credit crunch of 2007, when a run on property funds was an early sign of the financial crisis.
In 2007, a series of funds suspended redemptions in an apparent domino effect; in 2016, Standard Life’s “gating” was swiftly followed by that of Aviva’s £1.8bn UK Property Trust and M&G’s £4.4bn Property Portfolio.
But fund managers and others in the industry say much has changed since a race to the bottom in commercial property values helped to cripple banks and plunge the world into financial distress.
“This is not a Lehman Brothers moment,” said one fund manager in the sector.
UK banks already have much more capital than they did in 2008. That has given the Bank of England the freedom to relax its requirements in order to allow banks to continue lending — unlike in 2008, when credit was abruptly removed from the market.
Property companies, meanwhile, are far less indebted than they were ahead of the previous crisis, reducing the stress likely to result from them being unable to pay their debts.
“In the listed sector, levels of leverage then were about 45 per cent — today they are in the mid-20s to 30 per cent,” said Robert Duncan, analyst at Numis Securities.
The UK funds — some of the largest in the property sector — had little choice but to effectively trap investors’ money this week, after they were faced with withdrawal requests that ate into their liquid holdings. As open-ended funds, they are normally structured to return investors’ money on demand.
Investors fear that forced property sales by funds could act as a catalyst for steep drops in real estate values, as they did in the credit crunch, when UK commercial property prices shed 36 per cent.
“It might not be a re-run of 2008, with banks better capitalised to the tune of £150bn, but 2016 is shaping up to be a re-run of 2007,” said Mike Prew, analyst at Jefferies.
Mr Prew said he believed that the contagion could spread to real estate investment trusts, which experienced a fresh sell-off on Tuesday.
Meanwhile, open-ended property funds now own about 5 per cent of the UK commercial property market, compared with 2 per cent in 2007, after investors piled into the funds in search of yield and what for three years has been strong capital growth.
This increase in size could potentially heighten the funds’ impact on the wider market; in the past, inflows and outflows from such funds have closely foreshadowed changes in capital values for real estate.
The Bank of England, which held talks with property funds before the Brexit vote, on Tuesday highlighted commercial real estate as a risk to financial stability. “The behaviour of open-ended funds investing in the UK commercial real estate market could amplify any market adjustment,” the BoE said.
Many property funds — although not Aviva’s — had already written down the value of their assets by 5 per cent after the UK’s vote to leave the EU, anticipating a knock to commercial property values as businesses put on hold their expansion plans.
But analysts expect a bigger drop: those at Liberum are pricing in a 10 per cent fall, while real estate investment trusts are trading at an average discount of 32 per cent to the net value of their assets, according to Jefferies.
Investors have especially sold off stocks with exposure to London offices, which are expected to suffer from financial services companies relocating staff elsewhere in Europe.
However there are some factors that should ease the slowdown.
James Beckham, head of central London investment at Cushman & Wakefield, the property advisers, said the shock to demand would be mitigated by low vacancy rates — occupancy in central London is higher than during any of the past three market shocks.
“The central London market has become more globalised in terms of buyers, we’ve had a re-rating of sterling which we didn’t have previously, and you’ve got historically low interest rates which may go down as well as up,” he said.
Gating the funds will prevent the need for fire sales, but the funds will still need to dispose of properties relatively quickly to enable investors to reclaim their money, and this could set new benchmarks for pricing in the market.
Few commercial property transactions have taken place since the EU vote, while ongoing deals worth at least £650m fell through after the result.
There are fears that more funds may halt trading, said Mr Prew, although one large fund — L&G UK Property — said it had no plans to do so and maintained 20 per cent in liquid holdings.
Most funds are now carrying out weekly valuations to ensure they keep pace with the market, where any property deals that do proceed will be watched closely for signs of the new post-Brexit pricing and of buyer appetite after the vote.
“There is still the possibility of a devaluation spiral,” one fund manager said.