You may have heard recently that a number of UK commercial property funds have temporarily suspended all dealing or imposed exit penalties. The reason for this is to prevent the managers from becoming forced sellers of property (an illiquid asset) in the event of a high level of redemption requests following the Brexit vote. As you would imagine, selling a property in any environment is expensive and can take many months. In the current climate there is also the added risk that properties need to be sold quickly and, hence, at significant discounts to their fair value. In order to protect existing investors from having to bear a share of these costs, many funds have taken the decision to restrict all dealing until such time as they see the demand for redemptions subside. Other funds have instead imposed penalties on withdrawals (up to 15% in some cases). These are legitimate restrictions permitted by the Financial Conduct Authority, and the last time such measures were put in place was during the great financial crisis in 2007.
Why the panic? There is a fear that we have come to the top of the cycle and that the events of the UK leaving the EU have merely served to exaggerate the potential downside. However, in our view, the classic signs of the top of a cycle are missing. Interest rates aren’t high, aren’t rising, aren’t about to rise, and are probably going to fall, as Mr. Carney has made clear. The Bank of England is also encouraging the banks to lend to anyone who needs to borrow.
The London inner market looks vulnerable, for several reasons. It is more expensive than the rest of the country, and there has been more development. The City may also be a loser from the Brexit process. The market has also been buoyed up by overseas cash, none of which found its way beyond the M25, and some of this may be repatriated following the vote. The large unit trusts have been compelled by high investor inflows during the previous few years to buy large properties in London. These funds are most likely to be at the heart of this vulnerability.
Outside the City of London, it would be hard to argue that there is an excess of commercial property. There was almost no building in the regions during the previous crash of 2007 and in the years after (a consequence of the banking crisis, not a political one such as we find ourselves today), and much commercial land has been diverted to residential, which is more profitable for developers. Outside of London, the property market doesn’t have a ‘top-of-the-market’ feel.
Our preferred property funds have an underweight exposure to London and their average property size is much smaller than many of their larger competitors. We therefore feel, despite the dealing restrictions or temporary exit penalties applied, that our clients’ positions remain relatively sheltered from much of the current concerns. If negotiations with the EU go well, then perhaps many of the redemption requests will be withdrawn sooner rather than later.
Please note – this blog contains the personal opinions of James Payne as at July 12th 2016, and is not intended as financial or investment advice.