Property Funds Are Set for a Good Year, Despite Liquidity Worries

Property Funds Are Set for a Good Year, Despite Liquidity Worries
While liquidity concerns loom, the need for diversification will continue to fuel demand

March 2019, London. Flows into Europe’s property funds are likely to be more robust than those into other asset classes in 2019. This is because their diversification benefits attract investors—especially those with a longer-term outlook, according to the latest The Cerulli Edge―Global Edition.

Cerulli Associates, a global research and consulting firm, believes that liquidity remains a concern, given the risk of Brexit turmoil. However, it notes that the U.K.’s Financial Conduct Authority is seeking ways to avoid a repeat of the string of property fund suspensions in 2016. In the immediate aftermath of the U.K. voting to leave the European Union, several firms suspended trading in property funds for months. With investors rushing for the exit, properties could not be sold fast enough to raise the cash.

“Property funds have seen their share of turmoil in recent years. Brexit is an obvious cause for concern, given its effect on U.K. property funds,” says André Schnurrenberger, managing director, Europe at Cerulli. “But that is only the latest manifestation. Time and again, events have served as sharp reminders for the open-end property sector of the perils of daily dealing in funds in which it takes months to buy and sell the underlying assets.”

He notes that Germany’s property fund sector, Europe’s biggest, took years to recover from the financial crisis of 2008–2010. Now, however, the country’s open-end fund market is thriving, thanks in part, to regulatory changes that require new investors to commit for a minimum of two years and give a notice period for redemptions.

Cerulli flags up the risk created by U.K. retailers deserting high-street stores as more consumers switch to online shopping. This exodus is prompting some funds to shift their focus to residential property. Following recent changes to U.K. legislation, it is now easier for developers to switch the use of a building from commercial to residential.

Schnurrenberger cautions that fund providers should closely monitor whether the demise of the U.K. high street is replicated in other European countries. “All the indications are that the U.K. will not be alone in this regard. Diversification within funds, both geographical and in terms of type of use, remains crucial to minimizing risk,” he says.

“However, open-end property funds flows held up well in 2018, even as the mainstream asset classes, equity and bonds, struggled. Flows into open-end property funds in Europe were a healthy €7 billion (US$8 billion) last year. The need for diversification means that property will remain a significant part of most investors’ portfolios, despite the risk of it suffering some short-term performance issues as retail chains close outlets, leaving sites vacant.”

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Other Findings:

  • In Asia, Cerulli’s research shows growing interest in real estate co-investment from both small and large institutions. Although many prefer to make direct investments in this asset class, Cerulli believes there could be opportunities for external managers. It maintains that outsourcing co-investment is a win-win situation: fund managers get to build stronger relationships with investors and increase their chances of a successful fundraising; investors can benefit from cost savings, network expansion, and knowledge transfer.
  • The days when investors were satisfied with defensive strategies that entailed buying short-term out-of-the money put options to protect against sharp equity downturns are over, says Cerulli. The global research and consulting firm says that today’s investors are demanding more creative solutions to navigating the high premium and the drag, adding that more spikes in market nerves should be expected.

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