Are German Property Investment funds on the verge of collapse?
News that £21 billion worth of German property fund assets have been frozen could seriously impact on the UK property market. It was revealed that the between Tuesday and Friday of last week 11 German-based property funds suspended the right of investors to cash in their units for between three and six months. These so-called open ended investment companies have been a very popular property investment vehicle for some time
When you consider that some of the names involved in the frozen assets include AXA, UBS and Morgan Stanley you start to get a picture of how serious the situation could be. So what are the implications for the freeze on redemptions for both investors and underlying property markets?
Implications for investors
This is truly a serious development for investors and will impact upon the future reputation of open-ended investment companies as a form of investment into areas such as property. The main problem is the fact that property by definition is an illiquid asset which cannot be sold immediately thereby leading to delays in the delivery of cash to cover unit sales. There is also the implication that quoted asset values of the various funds today may actually bear little resemblance to proceeds raised from any fire sales.
Investors now have the double whammy of not being able to liquidate their assets and watching what will be a self fulfilling prophecy with fire sales of assets around the world impacting upon general markets and the amount of money raised. We will now see investors who had been overexposed to property markets start to panic and we could yet see a run on open ended investment companies similar to that seen in many banking sectors around the world.
A run on open ended investment companies will have serious consequences for the investment market and see investor confidence literary rally disappear overnight.
Implications for property markets around the world
The major concern with regards to the ever increasing number of unit redemptions in open ended investment companies is the fact that these need to be funded by the investment companies in question. Traditionally they would have retained sufficient funding on deposit to cover “normal” redemption numbers or else arrange additional finance so that no asset would be the subject of a fire sale where receipt of its true market value could not be guaranteed. However, this is not possible in the market of today
Various issues to consider
German property market
The German property market has been one of the worst performing for some time and despite a number of false dawns it has yet to really benefit from the convergence of East and West Germany sometime ago. The prospect of literally billions of pounds of assets dumped onto the market, the majority of which are commercial property interests, has the potential to push the property sector into a serious downward spiral. Not only will we see prices continue to fall but it will also attract even more distressed property asset sales in both the commercial and domestic markets.
UK property market
Historically German property investment companies have been very large investors in the UK commercial property sector which until recently had been one of the better performing around the world. The London commercial property market will be the area which is hit most severely and this will have implications for the wider commercial sector in the UK.
There is also the fact that a lack of property based finance in the UK will severely impact upon the number of potential buyers of these properties, forcing the underlying owners to move their sale prices lower and lower which in turn will drag the overall UK property market down. The implications of these potential fire sales of UK assets should not be underestimated.
International property markets
While the UK commercial property market has always been popular with German property funds they also have assets in most property markets around the world. The drip feed of yet more distressed asset sales is sure to affect local property investment companies in other regions and bring about the domino affect suggested above. There will also be an impact on companies who own their business premises as they will see their own asset values dragged lower and lower due to a distinct lack of buyers in the market.
While you might assume that property investors will be more than happy to pick up these distressed assets at attractive prices there will be growing concerns about the security of rental income from the companies occupying the premises. Quite where this will all end remains to be seen as there are so many negative factors coming into play it is difficult to see any positives.
The future
To say that the future of international property, both commercial and domestic, is clouded would be one of the biggest understatements of the year. A lack of finance, fewer buyers than ever before and a self fulfilling prophecy of lower and lower confidence in the market could see the international property market as a whole suffer for some time to come. We are also likely to see which investment funds have been overly dependent on specific sectors and areas of the market as these will be the ones which are hit hardest in the downturn.
Conclusion
Property investment companies have become a central part of the property investment market offering investors the opportunity to gain exposure in markets and sectors which they would not normally be able to obtain in their own right. While there are many benefits to holding property investment company units the main downside is the fact that as when investors decided to sell in bulk and additional finance is not available this can lead to redemption bars such as the 11 announced just last week.
The main concern now is that property prices will move lower as investors join the rush to redeem their property investment company units. This domino effect could literally ruin the property investment market for many years to come and reduce investor confidence in this type of vehicle. Normally any run on a property investment company would be financed from debt but as the commercial debt markets are still floundering this will not be an option for the vast majority of investment funds in question.