Real estate funds struggle to halt a race to the bottom

The sense of panic is unmistakeable, an echo of the mayhem that struck in 2008 — but this time it is different. Then it was largely about the banks; now fears are growing about the buildings they occupy.

Brexit has been the trigger for a near-nervous breakdown about the prospects for the development of commercial real estate, from London skyscrapers to provincial shopping centres. Will big companies risk putting staff in gleaming new towers at a time when jobs could be culled? Will retail chains open new stores as shoppers cut back on their spending?

Those fears have turned into urgent selling. Three of Britain’s biggest open-ended property funds have stopped investors from withdrawing their money to prevent a fire sale of the underlying property assets. The share prices of property companies have slumped, as have those of real estate investment trusts.

And the contagion is spreading. Mike Prew, an analyst at Jefferies, the investment bank, said it was “inevitable” that other funds would halt redemptions. A “vicious circle of value destruction” could follow, dragging in listed real estate investment trusts, he said.

The pattern has echoes of 2007-08, when a property crash was preceded by a wave of gatings — closures — by hedge funds and other vehicles that could not meet investors’ demands. Yet in one respect the danger for the property world is greater now than it was in the run-up to the last financial crisis, Mr Prew said, because open-ended funds own about 5 per cent of Britain’s commercial real estate market, compared with 2 per cent in 2007. Real estate investment trusts, or Reits, are an even more substantial problem, with 12 per cent of the market.

There is a specific challenge for open-ended funds. They can grow quickly in the good times, allowing investors to pile in more cash that can easily be put to work in the booming market for existing properties and new construction projects. The funds, which are heavily invested in regional developments such as shopping centres and office blocks, have done well compared with other investments in the past five years. They were recommended by many financial advisers to retail investors, as well as those from institutions, as a way to obtain exposure to Britain’s thriving commercial property market.

But there is a flip side to the coin. In the bad times, investors can demand their cash back and the underlying assets can take months to sell. That puts a squeeze on the fund manager, who has to eat into a cash buffer to meet investors’ redemption demands. The manager may also have to offload large commercial properties at a rock bottom price to free up investors’ capital. Another challenge is to reprice the fund when it is made up of assets that are hard to sell.

The problem is accentuated when demand for such properties is weak. Anne Richards, the new chief executive of M&G, joined Aviva Investors and Standard Life in buckling under the pressure this week and freezing redemptions. L&G, which has never imposed restrictions on its £2.5 billion fund, maintained that it would not do so. Henderson, which runs a £3.9 billion fund, said: “At the moment, we have nothing further to add.”

Even before the referendum, some investors were moving to cash out of their property-backed holdings. The Bank of England swooped in a few weeks ago, forcing property companies to increase the capital they held in cash or ultra-liquid assets to boost their ability to cope with a liquidity crunch.

That only partially solved the problem, as many funds hold cash in Reits and are now selling them rapidly, delivering another blow to the sector.

There is a also a vexed question of valuations. Alan Miller, the former New Star fund manager who runs SCM Private, said that funds had an obligation to reprice their funds under rules designed to ensure that they treat customers fairly. The fact that so few had in the wake of the Brexit vote was “astonishing”, he said.