Pressure rises on property funds and UK plc

Fresh signs of stress from some of the biggest fund managers have shifted the focus during a second week of turmoil for property players, while UK plc took the unenviable crown as Europe’s most distressed market. The UK has replaced Germany as Europe’s most distressed country for the fortunes of corporates, according to analysis from law firm Weil, Gotshal & Manges, which looked at more than 3,750 companies and financial market indicators. Real estate has risen to become the second most distressed sector, behind retail. The International Monetary Fund warned last month that the global real estate market could face “renewed pressure, especially in regions where economic growth prospects are weak”.  In the UK, the ongoing fallout from the government’s so-called mini-Budget has continued to move markets, with some semblance of stability emerging following a U-turn on tax cuts. But moves from several fund managers to limit redemptions from their UK real estate funds suggest difficulties ahead in the investment market. Gate expectations Schroders Capital UK Real Estate Fund said this week it had received withdrawal requests for £65.3m ahead of the redemption window ending on 30 June, equalling £65.1m based on the 1 September bid price. Those would ordinarily have been payable on 3 October, but the fund said it would instead pay £7.8m of the redemptions on that date with the remainder deferred until on or before 3 July next year.  The Threadneedle Pensions Pooled Property Fund has introduced deferred redemptions in the face of what a Columbia Threadneedle Investments spokesman described as “recent market volatility and a subsequent increase in redemption requests”. BlackRock too has changed its redemption process for its UK property fund, deferring redemptions requested during the second quarter that were due at the end of September. Other fund managers moved to reassure investors that it was business as usual for now. Mike Barrie, director of fund management for LGIM Real Assets, said: “Deferral is not in place on any LGIM Real Assets funds although, in very specific circumstances, it remains one of a number of liquidity management tools we have at our disposal to act in the best interests of investors.” At Calastone, which tracks fund flows, head of global markets Edward Glyn, said a “loss of confidence in property” during September “came in a month that saw record outflows of capital from both equity and mixed-asset funds, so this was not a property-specific problem”. He added: “The renewed pressure of outflows combined with the deterioration in the outlook for commercial property has prompted a number of funds to restrict redemptions again. This makes sense. Property is not a liquid asset. Investors who want to trade in and out of the sector are better suited to listed REITS, though they should be prepared to sell significantly below NAV at times of market disruption.” The borrowers UK REITs have been rocky since the mini-Budget, and although many have seen some recovery, big names remained significantly below their pre-Budget stock price as of 5 October, including FTSE 100 players British Land, Landsec and SEGRO. Investors’ eyes will now be on balance sheet resilience, said Berenberg equity analysts Keiran Lee and Tom Horne. The pair said that despite increasing loan-to-value levels in the listed sector, its fundamental strengths left “Armageddon unlikely”. “We expect the current interest rate environment to increase asset valuation yields, reducing asset values over our forecast horizon,” they wrote in a note. “The revised forecasts of our economists – lower GDP growth, increased unemployment rates, increased inflation assumptions and increased rate hike expectations – are also likely to pressure the sector more negatively, for longer, should they come to pass. We maintain our view that, once book values rebase to the current interest rate environment, the UK real estate sector is well placed to perform strongly in a period of higher inflation but higher growth.” With interest rates expected to rise further, companies have tried to show investors that their borrowing is under control. Healthcare investor Assura told shareholders in a trading update this week that its financial position is “very strong”. Chief executive Jonathan Murphy said: “Our debt book is fixed at an average interest rate of 2.3% with a long-term average maturity of 7.5 years, and we have cash and committed undrawn facilities totalling £284m.” At LondonMetric, the team said a further 100 basis points rise in benchmark rates would increase the company’s cost of debt by 20bps and reduce earnings per share by 0.2p on an annualised basis. “The portfolio’s reversionary potential and high level of inflation-linked rent reviews will allow us to mitigate rising interest costs,” it added. QE too With the Bank of England’s gilt-buying initiative due to run until 14 October, some are asking what impact the seeming reintroduction of quantitative easing could mean for investment in real estate. “If that drug [QE] is back in the system again” and drives down government bond yields, said Aviva Investors real estate managing director Ben Sanderson, “that will change a lot of investment behaviour and that might be very good for real assets”.  But economists argued it is too soon to see a direct impact on real estate deals. “The BoE’s gilt buying has already impacted gilt yields, pushing them back down under 4%,” said Walter Boettcher, head of research and economics at Colliers. “QE is not necessarily back, and the likelihood that the bank will use its strength to depress gilt rates intentionally to levels advantageous to real estate seems unlikely.” Savvas Savouri, chief economist at Toscafund Asset Management, said the buying of gilts is unlikely to return, arguing instead that the UK will re-enter quantitative tightening – or the reversing of QE. As for what that means for investment in commercial real estate, Savouri said: “We need to accept that we are back in the [2000-2007] period when UK CRE was out of yield bounds of UK buyers – remember the Irish out-bidding UK rivals because they could fund more cheaply than Brits. “The sad truth is that the war in Ukraine has not so much lifted global net wealth as shifted it. Shifted it in a way that will mean as ‘the West’ raises rates, these are cut where capital levels have risen sharply and the price of money fallen. So whilst it will be UK CRE, it will increasingly be owned by others.”    To send feedback, e-mail tim.burke@eg.co.uk or tweet @_tim_burke or @EGPropertyNews Image © Gerd Altmann/Pixabay