Property funds – ‘illiquidity’ strikes again

Physical property is an “illiquid” asset class meaning it can be time consuming and costly to buy and sell.

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  1. Rob Morgan

This week, M&G announced a suspension in dealing in its M&G Property Portfolio Fund. The move echoes the series of suspensions in ‘bricks and mortar’ property funds in the aftermath of the EU referendum in 2016, when investors tried to withdraw money faster than the funds’ managers were able to dispose of assets.

Why do suspensions occur?

Property is an ‘illiquid’ asset class meaning it can be time-consuming and costly to buy and sell. Unlike equities or bonds that can be usually be bought and sold readily, property transactions can take weeks, if not months. Anyone who has bought or sold a house will know of the sometimes protracted legal processes involved.

In addition, when realising assets managers of open-ended funds need to secure the best possible price, and the marketing process to find the right buyer is best carried out without being under undue pressure. To hastily dispose of assets such as offices, warehouses and retail parks risks creating a “fire sale” where fair value is not achieved, and this could unfairly impact remaining investors in the fund and depress the unit price for those exiting.

For this reason, property unit trusts and OEICs also tend to have to keep a cash buffer in order to fulfil redemptions and this can dilute returns. In addition, during periods where there is a particularly high level of units being sold property funds often alter their unit pricing structure in order to protect remaining investors from the costs generated by incoming or outgoing investors. However, when redemption requests exhaust the cash buffer then funds can suspend dealing in order to allow the necessary time to sell assets.

Figures from Calastone suggest £2.5 billion was withdrawn from UK property funds from October 2018 to the end of November 2019, with the asset class experiencing outflows for 14 consecutive months. This has taken its toll on the cash positions of some funds, hence the move from M&G. It is possible more funds could follow suit.

The outlook for UK commercial property

Commercial property, including offices, shopping centres and warehouses, have been affected by waning sentiment towards UK assets amid an uncertain political climate. There are fears that a slowdown in economic growth will mean significant falls in capital values, and more ‘voids’ where properties remain empty and no rental income is received.

Low interest rates support the case for higher yielding assets such as UK property. The area provides a high level of income versus most other assets and far exceeds cash or bonds and it can be less correlated with other areas – though the risks are higher. However, there is uncertainty surrounding the sector; largely because of political uncertainty and that the impact of the UK leaving the EU is still open to debate.

Valuing commercial property in this context is difficult, especially given that no two assets are the same. The market is a patchwork quilt of property types, sizes and geographies with some areas and sectors likely to experience greater demand than others. Many retail properties such as high street shops and shopping centres have also been under additional pressure from the increasing propensity of the UK consumer to shop online. However, there are still many retail assets that continue to trade well.

These factors shouldn’t necessarily worry investors with a long term outlook able to ride out fluctuations in capital value and enjoy a high level of income in the meantime. The problem of fund suspensions is a result of the structure of the funds not deficiencies of the asset class.

Tax changes for overseas investors

A further technical factor potentially depressing demand for UK commercial property is some recently-introduced tax rules, which effectively bring disposals of UK property assets by non-UK residents into the scope of UK Captal Gains Tax or, in the case of companies, corporation tax.

The legislation covers both directly held property and indirect property investments through certain funds. UK resident holders of ‘offshore bonds’ that invest in these assets may also be caught by the rule change as the legal owner of the investments, the bond provider, counts as being non-UK resident. The less favourable tax regime could dampen demand for commercial property among some types of investors.

The information in this article is based on our understanding of UK Legislation, Taxation and HMRC guidance, all of which are subject to change.​ Past performance is not a reliable guide to future returns. This article is solely for information purposes and does not constitute advice or a personal recommendation. If you are unsure as to whether an investment is suitable for you, please seek professional financial advice.​ No news or research item is a personal recommendation to deal. Investment decisions in fund and other collective investments should only be made after reading the Key Investor Information Document or Key Information Document, Supplementary Information Document and Prospectus. If you are unsure of the suitability of your investment please seek professional advice.

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