Has the UK commercial property market – already wobbling – been dealt a killer blow by Brexit?
Britain’s third-largest open-ended commercial property fund has just stopped investors from getting at their money.
The £2.9bn Standard Life UK Real Estate Fund has suspended redemptions for “at least 28 days”. In other words, if you have money in the fund, you can’t get it out.
It’s the first in the sector, but unless this is very unusual, it won’t be the last.
So what’s next? …
Is Brexit the last straw for the UK commercial property market?
The last time that commercial property funds in the UK suspended redemptions was just before the financial crisis. So news that Standard Life has just “gated” its real estate fund isn’t very reassuring – particularly given the apparent speed of outflows.
As Jonathan Guthrie reports in his Lombard column in the Financial Times, at the end of May, the fund had a hefty cash cushion of 13% of its value, put aside for this very eventuality. “Investors must have made heavy inroads into this amount” to drive the “gating”.
Brexit on its own might not have been so bad. But the commercial property sector was already looking a bit wobbly before the big vote. Judged by various indicators – including office space in development and rental yields – prices are near or above where they’ve been during previous peaks.
Notes Guthrie: “Land Securities and British Land, the UK’s two largest property companies, reined in their loan-to-value ratios in anticipation of a real estate downturn well before the Brexit vote.” Other big commercial landlords had warned that the London boom was on its last legs.
So the market wasn’t cheap. And several funds in the sector had already shifted their pricing regime to reflect this. So will the shock of Brexit be enough to push this wobbly sector over the edge?
Truth is, we’ll just need to wait and see. If Standard Life has to sell off assets quickly and other funds lose money at a similar rate of knots, forcing more asset sales, then yes, this could turn into something bigger. Alternatively, if the underlying market remains relatively healthy, it may be more like a correction.
If you own this fund, or one of the other big players in the sector, I’d suggest that you don’t panic. There’s not much you can do at this point, and clearly you shouldn’t be using this sort of fund as an instant access account.
However, I would avoid drip-feeding any more money into such funds. If you really want to invest in commercial property, there’s a much better way to do it, which we’ll get to in a moment.
A valuable lesson in the appeal of investment trusts
At a practical level, this is another very clear demonstration of why it makes sense to avoid investing in illiquid assets using a financial instrument that promises daily liquidity.
Because this is what happens when the fund manager can’t sell the underlying assets quickly enough to satisfy the number of investors who want to sell out of the fund.
This isn’t just a problem with property. Those with slightly longer memories might remember the demise of New Star’s Heart of Africa fund back in 2009 for pretty much the same reason. People wanted out of the fund at a faster rate than the manager could flog off the illiquid underlying assets.
Now I’m not sure why the fund management industry insists on offering commercial property via open-ended funds. But there’s an easy solution for any investor who wants to avoid this sort of problem. If you want to invest in commercial real estate, buy an investment trust.
We’re fans of investment trusts at MoneyWeek, as regular readers will know. An investment trust is simply a company that invests in other companies or assets. It’s listed on the stockmarket. In effect, it’s a lot like an open-ended fund (a unit trust or OEIC), but with a critical difference – because it’s listed, the share price of the fund can move independently of the value of the underlying portfolio.
This means that you can always sell out. When you sell shares in an open-ended fund, the manager has to raise money to pay you. If that means selling a few blue-chip shares, that’s easy. If it means selling an office block – well, that’s going to take a bit more time.
But when you sell shares in an investment trust (or closed-end fund), it has no impact on the underlying portfolio. The price you get will depend on supply and demand for the shares themselves, not the value of the portfolio. Thus the share price of the investment trust can trade at a discount (below the value of the underlying portfolio) or at a premium (above the value of the portfolio).
So you might not be able to get your money out at the price you want. But you will always be able to get it out.
I’ll certainly be keeping an eye on commercial property over the next few months to see how things pan out. This could turn out to be a good buying opportunity for some of the bigger property investment trusts, which are now trading at big discounts.
But it depends on how the wider market pans out – as I’ve already noted, this stuff wasn’t cheap, so chances are it needs to blow off some froth anyway. There’s no rush here.
Meanwhile, we’ll be updating on the MoneyWeek investment trust portfolio – and how it coped with the Brexit shock – in the next issue of the magazine, out on Friday.
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