Earlier this month two popular property funds in Ireland the Irish Life Irish Property Fund and Aviva-managed Friends First Irish Commercial Property Fund both revalued their funds on a “disposal basis” resulting in significant mark downs in value to investors. Aviva also went one step further and stopped investors in the Friends First fund from taking money out for up to 6 months. According to the companies this was as a result of an increase in investor redemptions.
A similar thing happened with several property funds in the UK post the Global Financial Crisis, post the Brexit referendum and also more recently with M&G Investments suspending redemptions from one of their property funds due to an increase in withdrawal requests. And of course, we saw many property funds in Ireland do something similar when the Celtic Tiger era came to a juddering halt as a result of the Global Financial Crisis.
With all of this in mind we think it is worthwhile looking at the differences between types of property funds.
Direct Property Funds
Direct property funds do not have a fixed number of shares. When you invest money in the open-ended Fund, the fund creates new shares and your money is added to the fund. The fund then uses this money to buy property directly. When you redeem your investment, the shares are cancelled, and the fund needs to pay out cash from the fund. This need to pay out based on cash reserves can lead some funds to hold high levels of cash as a liquidity buffer, which is a problem when interest rates are negative.
The price of the fund is based on the net asset value – the value of the buildings, offices and properties owned by the fund. However, the underlying value of the holdings is generally only appraised annually so the true value can be hard to ascertain leading to artificially low measures of volatility. In effect, the funds are much riskier than they look from a unit-price volatility perspective.
This structure can also be problematic if many investors decide to sell at the same time. The manager may not have the cash to hand to pay out and may then be forced to sell property holdings – and this can take time or lead to selling substantially below market prices.
Other issues with this type of structure may be a lack of transparency and often a lack of geographic diversification.
Listed Property Funds
A listed property fund, on the other hand, invests in Real Estate Investment Trusts (REITS), and sometimes listed property companies, which are listed on a stock exchange. REITS have a fixed number of shares. They can raise money by selling shares much like a company can raise money by selling shares to the public. Cash raised is used to invest in various property investments. Like a stock, the price of these investments are based on what investors are willing to pay. As a result, the value of a REIT may be above or below the Net Asset Value.
In the situation described above where many investors decide to exit a listed property fund at the same time, there will not be the same liquidity issue as with direct funds. Whereas it takes a long time to sell physical property, it is the work of moments to sell a REIT or a listed property company (although the sales may be at a reduced price when lots of investors are trying to sell at the same time). Thus listed property funds should always be able to honour redemption requests from investors. .At PortfolioMetrix we favour investment in property via funds that invest in a diversified portfolio of REITS and property shares with property holdings across the world. This has the benefit of global diversification as well as liquidity.