After various consultations, recommendations and analyses are emerging from various bodies following the ‘redemption panic’ for open-ended property funds post the Brexit referendum. This is discussed very well in a piece in the FT today. Similar to banks who promise to repay all their customers deposits whilst only having a small fraction of them available, open-ended property funds attempt to provide liquidity for assets (the fund units) based on the values of the underlying illiquid properties. Like bank runs, things can go haywire pretty fast when too many investors try to sell their units at the same time.
Even establishing fair pricing of the units is a problem. The unit pricing is based on appraisals of the properties which everyone knows have some uncertainty. Normally, investors live with it. In rapidly deteriorating market conditions, the appraisal uncertainty can shift from a chronic to an acute state. In a sharp market downturn, trading volumes tend to fall dramatically and appraisers tend to find themselves with little or no transaction evidence upon which to estimate the size of the falls in values that has occurred. The basic problem is that real estate transactions cannot take place as quickly as market sentiment can change. It is then impossible for the private real estate market to generate hard evidence of short-term price changes due to the length of transaction times that, at a minimum, are measured in weeks and, typically, take months. Adrian Benedict, investment director of Fidelity International’s real estate arm, summed up the problem well last year.
“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.”
In reality, they did!
The funds needed to ensure that the exiters weren’t able to exit at unit prices that were too high (and did not reflect any short-term price falls) and that the remainers weren’t paying the paying for this privilege. In order to ensure fairness to exiters and remainers, most of the funds had to either prevent redemptions and/or make what is termed a “Fair Value Pricing Adjustment” to reflect estimated asset value changes that have occurred due to a change in market conditions, abnormal uncertainty in the appraisal in a period of stressed market conditions and the possibility that assets will have to be sold in an abnormal sale process to meet redemption demands.
Easy to say, harder to do. In reality, different funds took different guesses at this adjustment. There don’t seem to be any easy answers here. However, my colleague Steven Devaney and myself think that in periods of such short term volatility, you have to look at what is happening in the listed real estate sector where you can see actual hard evidence of price changes. Controlling for their different levels of gearing (but not exposure to development, or non-UK holdings), we estimate that the changes in the share prices of the major REITs in the week following the referendum
Geared and ungeared price changes of UK REITS from 23-30 June 2016
|Estimate of gearing on 23 June||Share price change from 23 to 30 June||Ungeared share price movement|
|Great Portland Est||20%||-18.7%||-14.9%|
Segro provide a reasonable proxy for the warehouse sector, INTU for the shopping centre sector etc. Overall the average implied price change was a fall of 10%. It’s not that far off what many funds actually did. It’s pretty rough and ready and can be refined but in the absence of any other evidence, it’s better than nothing.