The open-ended real estate funds continue to attract a lot of attention in the media. In today’s FT, there’s a piece that mentions the potential vicious circle caused by ‘fire-sale’ prices as the open-ended funds are forced to quickly sell (what are often their best) assets at discounted prices in order to meet the demand for unit redemptions from investors. The vicious circle hypothesis is that such discounted sale prices are used by valuers to ‘downvalue’ the fund’s remaining assets, ‘down valuations’ fuel demand for further redemptions, there are more sales at discounted prices and so on.
The FT article refers to the experience of the GFC.
In 2007, a series of funds halted trading and were forced to sell buildings at fire-sale prices, amplifying a drop in real estate markets and contributing to the credit crunch
Something like the ‘amplification theory’ (I’ve made that term up) was also proposed by Ben Bernanke in 2008. His core argument was that any mis-pricing would normally be identified but that when buyers became scarce, prices could become unstable creating a downward price spiral. His argument was that government intervention was needed to establish more rational pricing and that was the policy in the end.
fire sale pricing and the markdowns that it creates for banks that is one of the sources of why capital is being reduced and why banks are unable to expand credit…it’s possible for the government to buy these assets, to raise prices, to benefit the system, to reduce the complexity, to introduce liquidity and transparency into these markets and still acquire assets which are not being overpaid-for in the sense that under more normal market conditions, and if the economy does well, most or all of the value can be recouped by the taxpayer
If open-ended funds do sell, are the prices obtained artificial in any way? If the assets have been marketed normally and the price obtained reflect what ‘the market’ is prepared to pay, then it is difficult to argue that that they do not constitute evidence of pricing levels. Just because many investors won’t sell at reduced market prices doesn’t mean that such prices aren’t the current market prices. (Bernanke might argue that, if there were very few buyers because of a major credit crisis, then the prices could be artificial in some way.) However, if investors are not marketing their assets normally e.g. are selling ‘off-market’ or are trading off prices for speed of sale e.g. taking a lower price in return for faster transaction execution, then it may be that such prices do not reflect what another investor could sell the asset for in a normal sale process. Tricky stuff for valuers. It’s hard to see such a dramatic downward spiral. Open-ended funds only account for about 5% of the market.