Open-ended property funds and the illusion of liquidity

There are certain investment lessons that are obvious, but never seem to be learned. “Don’t expect instant liquidity from illiquid assets” is pretty high up that list.

Yet several open-ended property funds are again restricting redemptions – just as they did in 2016 and 2020 – as result of too many investors trying to get their money out too fast.

On this occasion, only institutional funds (ie, those used by pension schemes) seem to be affected, unlike last time when retail investors got locked in as well. However, it’s not hard to imagine that retail funds may eventually limit withdrawals, if the real-estate downturn continues amid higher interest rates and a weak economy.

MoneyWeek has set out its views on this many times in the past: we simply don’t see any sound reason to invest in open-ended property funds that promise easy liquidity, because that liquidity will always disappear when investors want it most.

By contrast, listed real estate investment trusts (Reits) have continued to work as designed. If you want to sell, you can sell any time the stockmarket is open. If you want to buy, you can buy.

Pricing in a lot of gloom

Sure, prices have dropped a lot this year. Among the big office and retail Reits, British Land is down 37% year to date and Land Securities is down 34%. London office specialist Derwent is off 43% and its peer Great Portland is down 38%. Capital & Counties and Shaftesbury, which own large swathes of London’s West End and are set to merge later this year (Competition and Markets Authority permitting), are down 41% and 44%. Even logistics Reits, the market darling in recent years, are off: Segro is down 47%.

But that’s the market doing its job – pricing in the bad news. Maybe it’s too pessimistic and too focused on the short term – but investors who agree benefit from the ability to sell whenever they want. Investors who don’t can simply hold on. That’s better than being in funds whose value depends on valuers’ assessments of what properties are worth and where the manager decides when you can get money out.

Personally, I acknowledge this bearish market could be more right than me – but after such a big drop, I am starting to buy, while being conscious that we may have further to fall. As previously noted, I reckon that Reits with prime properties, reasonable leverage and long debt maturities will come through okay and then begin to grow dividends in real terms as we recover from the pandemic.

Thus I have ditched some European real estate, where I was no longer confident that was true, buying a bit into Capco/Shaftesbury (which previously seemed too expensive to me) and am starting to look at logistics again.