Vexing valuations

There’s a good story by Aime Williams in the FT about the open-ended property funds and their forthcoming valuations. During the GFC, the sharp downturn then generated lots of speculation that different types of institutional real estate investors had incentives to try to influence their appraisers in different directions.  The pressure for open-ended real estate funds to meet high levels of demand for redemptions gave them strong incentives to ensure that their asset valuations were quickly marked (downwards) to market. In contrast, it was suggested that other investors, such as REITs and closed-end funds, had incentives to resist falls in their asset valuations in order to shore up share prices or to comply with banking covenants.  In some research with colleagues at Reading and Cambridge, we found that open-ended funds were more likely to experience value falls compared other investor types in that period.

According to Aime Williams, echoing 2008 events, funds are starting to value weekly rather than monthly. There seems to be a consensus that values have fallen by around 5%.

The fund house (Henderson), the UK’s third-largest listed manager, has lowered the price of its UK property fund by 5 per cent following advice from its independent property valuers, CBRE Limited…Standard Life Investments followed Henderson on Tuesday, announcing that it would make a similar 5 per cent reduction to the value of the assets in both its SLI UK Real Estate and SLE Pooled Pension Property funds… Legal and General also devalued its UK property fund portfolio by 5 per cent on Wednesday, while Aberdeen Asset Management reduced its fund value by 3.75 per cent.

It would be interesting to know how they arrived at this figure. I suspect that it might be linked to the performance of the listed sector.  The Land Securities share price fell by around 15%-17% over last weekend.  Their low gearing ratio would imply a hit of about 10%-12% in asset values.  The share price recovered quite a lot and at current prices – 5% feels implicitly plausible.

An alternative view was expressed by other investors and their valuers.

M&G’s fund is one of the largest open-ended UK property funds with assets under management of £4.5bn. The company said its valuers, Knight Frank, looked at the portfolio on Monday but as yet see “no significant change in valuations based on the property transactions they view”.

Transactions take months to do – so it isn’t really a surprise that they didn’t see any evidence of price changes involving actual transactions over a weekend.  It would be interesting to know how much communication is going on between the valuation firms. Are they trying to present a consistent front to their clients?

Before the referendum, property valuers broadly agreed to devalue UK commercial real estate by 10 per cent in the event of Brexit, according to Jefferies, the investment bank…However, because of the slow pace of buying and selling real estate, price swings have not yet been confirmed by the market.

How can they know? Why 10%? Are they just making up numbers?  It’s hard to disagree with Adrian Benedict, investment director of Fidelity International’s real estate arm, reported as stating the obvious – that valuers were currently uncertain of the current price of property.

“What we have seen [is] valuers stating you cannot necessarily rely on the independent valuation as a true gauge of pricing in the market given uncertainty,” he said. “At the heart of it is their concern that funds, particularly those that are daily dealt, are trading on prices which cannot be truly ‘marked to market’ just now — sentiment may have turned negative and pricing is possibly falling but in absence of any deals actually having completed, the valuer can’t mark down valuations.”

That’s just what they appear to be doing. It’s a difficult dilemma – especially for open-ended funds.  Although there’ll be a performance hit, most investors will not realise any losses because they won’t sell.  However, for open-ended funds without strong cash reserves, redemptions can only be made through asset sales. Unless asset values are marked to market accurately, exiting investors will receive payments above sale value and it is the remaining investors who cover the losses eventually.  Can’t get away from exiters and remainers.

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