A home for property

Here we go again. As market volatility has accelerated over the past 10 days, property funds have responded in a way that is all too familiar. Three of the UK’s largest asset managers have warned they can’t cope with the volume of withdrawals investors are making from their property funds, and that they’re restricting or delaying redemptions as a result.

This time, the trigger for the crisis has come from pension funds. As part of their scrambled response to the sharp rise in gilt yields of recent weeks, these funds have been liquidating their holdings of other types of asset – with property funds bearing the brunt of their demands for cash.

For traditional property funds, meeting those demands can be very difficult. While they maintain a cash buffer to manage inflows and outflows into their funds in ordinary times, most of their money is tied up in an asset that is difficult to buy or sell quickly, particularly at a reasonable price. When too many investors want their cash back, property funds therefore face an insidious choice – they can sell assets at fire-sale prices in order to fund withdrawals, or they can refuse to allow those withdrawals for a period. Either way, investors suffer.
 

We’ve seen two other examples of a liquidity crunch in the property sector in recent years. Large numbers of funds were forced to restrict withdrawals in the wake of the Brexit vote, and then at the height of the Covid-19 pandemic. The problem then was both the scale of demand for withdrawals and the difficulty of valuing any asset, including property, amid a crisis.
 

What will really irritate many investors this time around is that these latest restrictions follow moves by pension funds that have nothing to do with their views about property as an asset class in their own right. This isn’t a vote of no-confidence in real estate; rather, pension funds have simply found themselves forced to raise cash in a hurry.
 

Generally speaking, of course, the prospect of slower economic growth – let alone outright recession – does tend to augur ill for property. If consumers spend less money in shops, companies start letting people go, or businesses limit production, the demand for retail units, office accommodation and industrial capacity will naturally take a hit. Equally, the combination of rising gilt yields, higher interest rates and a falling pound represents a potentially toxic mix for the sector.
 

Still, there are plenty of investors who remain convinced of the medium and long-term value of commercial property assets, to generate both income and capital gains. In the short term, moreover, market analysts are beginning to wonder whether the historically low valuations of some property companies and real-estate investment trusts could lead to a spate of M&A in the sector. The analyst Jefferies, for example, recently noted, “assets worth more in private than public market may pave the way for REIT M&A”.
 

The question investors in the sector now need to address – yet again – is how and where they get their property exposure. It is clear that despite endless discussions about regulation and restructuring, traditional property funds remain just one crisis away from closures and restrictions.
 

In which case, step forward investment companies. For years, the closed-ended funds sector has offered a way into property – and plenty of other illiquid assets – that doesn’t suffer from the issues characterising other types of collective investment vehicles. Investment company shares are traded on public markets – when investors want their money back, whatever the circumstances, all they have to do is sell their stock. The fund manager never has to worry about the underlying assets in this regard.
 

Slowly but surely, the penny has dropped with investors in recent years. Investment companies are increasingly becoming the default option for those looking for exposure to property through a diversified collective investment vehicle. The latest worries about other types of fund will (and should) only hasten that trend.