UK direct property funds have started to lift the temporary dealing suspension placed upon them because of Covid-19. How will this impact investors?
UK property funds were suspended in March 2020 following the deployment of a ‘material uncertainty clause’ by independent property valuers. This meant that the valuer was unable to provide an appropriate level of certainty regarding the valuation of the asset and was a direct result of the impact of Covid-19 and lack of property transactions as the nation was in lockdown. Funds suspended dealing until such time that a more certain valuation could be ascertained with the aim of ensuring the fair treatment of all investors, whether they were transacting presently or investing for the longer term. As lockdown restrictions have been lifted and there is more transaction volume, independent property valuers have been more confident and have been able to lift the temporary dealing suspension.
Whilst fund suspensions are disruptive, they are an important and effective way to ensure no investors are disadvantaged during times of exceptional market uncertainty.
Issues for investors
One issue for consideration is that of a rush to get money out when a fund reopens, which may cause it to close again. Property funds are often suspended based on a liquidity mismatch – the funds are daily dealing, but it takes many days to sell a property to raise cash for investors. Therefore, investors may panic and seek to get their money back, causing a further suspension to the fund. However, some property funds are only accessible by institutional pension funds and have a more stable client base with a long-term investment horizon; in these instances, investors should not panic and sell as fund liquidity should not be an issue.
Particularly since Brexit in 2016 – when many property funds were suspended based on liquidity grounds – we have seen property funds with a high allocation to cash. This has followed on from the unknown impact of Brexit to the UK property market, affecting investor appetite. Such funds should be able to handle some redemption requests.
Future of property
Whilst the funds may open there are still material challenges facing the property sector. As more people work and shop from home, offices and retail units will experience capital value declines. Rent collection and, therefore, fund yields may also decline as many tenants will not be able to pay rent. The most affected tenants are in troubled sectors, particularly in the retail and leisure space such as cinemas. These sectors are likely to experience significant write downs.
A growing trend within DB pension schemes is to allocate to Long Lease Property funds (LLP). They only invest in assets with a long lease, often 25 years (average UK balanced funds is c.7 years). Due to the long duration of the lease, the main risk of these funds is credit risk. If the tenant goes bust, they could be hard to replace which could lead to write downs. Given the economic uncertainty and potential for many defaults, these funds may not provide the level of protection as intended. Many did not exist during the last financial crisis making it hard to predict the outcome.
In summary, property, like many other asset classes, is adversely impacted by Covid-19. However, it does still provide portfolio diversification and is an attractive income yield which will reduce volatility.