REITs can solve property funds’ ‘inherent design flaw’

As M&G gates its £2.5bn property fund, Cohen & Steers chief executive Bob Steers urges investors to focus on liquidity. It is imperative investors consider the importance of liquidity in real estate allocations. Lock-ups of daily-dealing open-ended funds investing directly in real estate – occurring in 2008, in 2016, and now again in 2019 – have exposed the inherent design flaw of relying on cash buffers to liquidity in times of market stress. Liquidity is rarely an issue when times are good and the supply of capital is strong. But liquid reserves built into direct property funds can quickly evaporate. Now is the time for the UK’s Financial Conduct Authority to act. It should consider the example of the US, where open-ended “bricks and mortar” property vehicles only allow redemptions monthly or quarterly, while daily-dealing open-ended mutual funds have strict limitations on illiquid holdings. The result: of the many thousands of US mutual funds in existence since 1972, only six have suspended redemptions, according to the Investment Company Institute. The UK cannot say the same. Germany has also taken action. The country’s open-ended property fund market experienced its own existential threat during the global financial crisis, with many funds suspending redemptions. In fact, funds holding almost €20bn of real estate assets had to be wound down in the aftermath of the crisis. In response, the German authorities removed daily dealing and introduced a two-year initial holding period, with a one-year notice period for redemptions. Investors in the UK do not need to wait for the FCA to act. A liquid solution for property investment is readily available in the form of listed real estate securities, which investors in most developed markets have embraced. The adoption of real estate investment trusts – now present in more than 30 countries – has driven significant growth of the global listed property market, currently valued at nearly £1.5tn. Yet many UK investors remain unfamiliar with them. It is only a matter of time before UK investors and the FCA accept REITs and other real estate securities are more appropriate for open-ended daily liquidity vehicles.