The closure and suspension of several open-ended property funds in recent weeks have raised questions about the stability and the future of the investment vehicle.

M&G (MNG), St James’s Place (STJ) and Canada Life all have funds in the spotlight, on the back of heightened investor redemption requests that are pushing the strategies to make sales. 

Experts say most asset classes within commercial property are struggling. Office and retail properties are currently experiencing reduced investment and fewer completed sales compared with recent years.

According to MSCI’s monthly property index, the value of all UK property dropped 19.8% in the year to the end of September.

Investors are now asking how hard will it be to offload certain properties, who the potential could buyers be, and how much of a haircut fund owners will have to stomach

Months, if not years, to sell

The illiquid nature of real estate investments held within liquid investment vehicles, such as property funds, creates a fundamental mismatch.

Daily dealing (the ability to buy and sell assets on a daily basis) is a hallmark of modern financial markets. However, when it comes to physical properties, this concept doesn’t hold water, according to Marcus Phayre-Mudge, who manages the £337m Columbia Threadneedle Property Growth and Income  fund and TR Property (TRY ).

Phayre-Mudge (pictured above) said real estate assets, often comprising large, illiquid structures, can take months, if not years, to sell.

Canada Life and M&G have said it will take between 18 months and two years to wind up their funds. 

The result? A fundamental disconnect between investors’ expectations of immediate liquidity and the realities of property transactions.

‘Open-ended, daily dealing and physical property are six words that shouldn’t be in the same sentence,’ said Phayre-Mudge. ‘Investors should, and want to, have exposure to commercial property as part of their balanced portfolios. But they’ve been ill-served because the investment community all created these open-ended funds.’

Oliver Creasey, head of property research at Quilter Cheviot, said SJP’s and M&G’s ‘nuclear decisions’ to respectively suspend and close their funds indicates that selling their current properties will not be a ‘walk in the park’. He added that had they thought they could sell their properties within six weeks for a decent price, they would have done so without needing to take such drastic measures.

‘I don’t think it’s going to be trivial for them to get back on an even keel and just get everything sorted,’ said Creasey. ‘At least some of the properties they hold are going to be a real challenge to shift right now. But I suspect everyone’s got something hidden away in their portfolio that’s a challenge [to sell].

Creasey (pictured above) also echoed Phayre-Mudge’s comments, adding that the model of having an illiquid asset in a liquid vehicle is a ‘problematic mismatch’.

He said that while property funds have historically maintained cash reserves, this approach is not foolproof as there may still be periods where cash holdings fall short during a wave of redemptions.

Are there decent assets?

Within this challenging landscape, property funds have shown a preference for selling industrial properties as these tend to be more liquid. While selling office buildings or high street shops is possible, it can be more complex, often requiring a deeper dive into the market to find the right buyers at fair prices.

Creasey believes retail spaces including shopping centres, in particular, have proven challenging to sell, with few transactions occurring.

According to a report, Canlife UK property  fund held about 22.8% of its portfolio in retail properties at the end of June 2022.

While at the end of March this year, M&G Property  fund allocated slightly more than 18.3% to retail properties, valued at about £116m.

On the other hand, SJP has about 3.7% of its now-suspended fund dedicated to shopping centres and high-street retail properties.

‘Shopping centres have historically been just about the hardest thing to settle,’ Creasey said.

‘We’ve seen an absolute dearth of transactions in that space, and it tends to be that the only people who ever transact on a shopping centre are people who already own it. So, if you own 50% of a shopping centre in a joint venture, we do occasionally see people buy out the other party.’

Picton Property Income (PCTN) chief executive Michael Morris said the buyers are likely to be pension funds, overseas buyers, private equity or institutions with longer-term time horizons.

He also said that although fund managers might want to sell their assets as a single portfolio, it is more likely the assets could be sold individually or as distinct components.

‘What you’d probably like to do is sell as a whole, so as not to have a sub-scale vehicle and a decreasing tail of less liquid assets,’ he explained. ‘That’s where it gets difficult, especially in this market. It’s likely that assets may be packaged by sector to avoid [selling individual properties].’

Phayre-Mudge believes sectors with long-term secure income, such as primary healthcare centres operated by the NHS, retail warehousing, supermarkets and logistics, are likely to sell quickly and remain attractive to investors. The rise of omni-channel strategies and convenience-driven retail warehousing due to Brexit and Covid has made it a particularly interesting segment.

‘We are an island and if the port of Dover was to shut, we would have a problem pretty quickly,’ Phayre-Mudge said. ‘Lots of companies are storing more parts [and] are shortening their supply chain. This applies across all of Europe as well.

‘We are seeing this constant demand for storage [such as] urban logistics in built-up environments.’

On 30 September, St James’s Place held 56.6% of its portfolio in industrial and retail warehouses, including an 8.2% share in J31 Park, a multi-tenanted industrial/warehouse estate in West Thurrock, which is currently available to let.

Canada Life’s property fund has 19.7% of its portfolio invested in industrial and retail warehouses, including shares in a £14.4m trade centre in Basildon and a £14m trade park in Milton Keynes (although the complex has been put up for sale recently for less than £10m).

Sectors that have shown resilience

• Healthcare: Properties with long, secure income streams backed by government institutions.
• Retail warehousing: The surge in online shopping and click-and-collect services has bolstered this sector.
• Logistics and industrial: The increasing demand for storage and the nearshoring/onshoring trend have made these properties attractive.
• Residential: The private rented sector offers opportunities for institutional investors to provide stable, long-term housing solutions.

Lingering regulatory uncertainty

Creasey and Phayre-Mudge said that despite the glaring liquidity mismatch, the regulatory response has been inadequate, leaving investors and fund managers in a state of limbo.

In August 2020, the FCA opened a consultation process that it followed with feedback in May 2021.

However, there has been no update since then, with the lack of clarity regarding potential regulatory changes, if any, leaving ‘a dark cloud’ hanging over the sector, according to Creasey.

Phayre-Mudge remains amazed that the FCA didn’t crack down on this issue much earlier.

‘Instead, they’ve just allowed the market to basically solve itself, which is essentially investors taking their money out then the management house saying: “We can’t give you your money back. Therefore, we suspend the fund.”’

Proposed regulatory changes such as imposing redemption delays of three to six months, have generated mixed opinions. While such measures may provide a buffer against sudden redemptions, they may not be a one-size-fits-all solution.

Additionally, these changes might affect the eligibility of property funds for tax-efficient savings vehicles, such as ISAs.