It has been announced today that Scottish Widows, which is owned by banking giant Lloyds Bank, has suspended redemptions of units in its Life Property Fund. This means that policyholders who have exposure to the £596 million fund will not be able to redeem any of their units for at least 180 days. This is the latest in a long line of property funds which have effectively locked investors into the commercial property market for varying periods.
The Scottish Widows move comes quickly on the heels of similar moves by Norwich union and Standard Life amid concerns that investors are set to pay the price for the downfall of the UK property market. As these funds have the majority of their exposure in the commercial property market there is concern that prices are in freefall and the value of a property fund investment today could be substantially lower by the time the redemptions ban is lifted.
Why have the property funds introduced the redemption ban?
In simple terms, more and more property funds are looking to block unit redemptions simply because they do not have enough liquid assets available to pay investors. As the vast majority of their assets are invested in commercial property this is not something which can be liquidated overnight let alone the fact that buyers are very rare in the market at the moment.
In “normal markets” these property funds will hold sufficient capital on deposit to cover any excess redemptions but we are not dealing in traditional markets at the moment which has seen many property investment funds short of liquid cash. While investors are obviously concerned about the inability to cash in their investments in the short term the situation is clearly defined in the small print of a variety of property funds were orderly markets are the main aim during varying market conditions.
Surely these property funds can raise extra cash against their investments?
Yet again, in more traditional markets it would be possible to take out further loans against property assets but we are not working in traditional markets and it is proving ever more difficult to value commercial property on a fair basis. As we saw in the housing market, commercial property investors have literally dried up and sellers have been forced to take lower and lower prices (often submarket) for their once valuable assets.
On a financial front there is also the fact that the UK banking system is still very much in disarray and looking to reduce exposure to the UK commercial property market rather than increase liabilities in this region. As we have covered on a number of occasions, there is speculation that UK banks have in excess of £200 billion of commercial property write-offs to bring through in the months ahead, which will further increase selling pressure in the property market. Even if the banks had sufficient capital to consider loans against property assets what is the correct value of any commercial property asset today?
Is this fair on investors?
Many investors have been outraged by the various bans on redemptions in the short term and their concerns are completely understandable, however there are terms and conditions attached to these various property funds which cover such markets as those seen today. While the property investment companies would argue that the blanket ban on redemptions will allow them to liquidate sufficient assets in an orderly manner there is the obvious chance that property prices could move further down before the redemption ban is lifted.
As a consequence there is a chance that investor assets could be worth substantially less by the time the redemption ban is lifted although unfortunately there would be no recourse to the fund managers for any form of compensation. This has probably focused the minds of property investors, who use property funds, to the fact that property is deemed to be a long-term investment although there are obvious short-term implications such as the current market conditions.
The commercial property market
The leading property index provider IPD released figures on Monday which show that commercial property assets in the UK have fallen in value by 34.3% over the last 18 months, which has completely wiped out the impressive investment returns of the last five years. In effect the UK commercial property market is back to the level of 2002 but there are serious concerns of further losses in the short to medium term.
Aside from the fact that finance is becoming ever more scarce, we are seeing more and more tenants struggling to make ends meet and substantial numbers of UK companies going out of business. Even if a property landlord was able to replace a bankrupt tenant it is highly unlikely they would be able to obtain a similar rent to that from agreements prior to the credit crunch. This then reduces the cash flow associated to any property asset and in real terms reduces the ongoing value of the property.
Is there a backlog of commercial property up for sale?
While the likes of Norwich Union, Standard Life and now Scottish Widows have suspended redemptions on their property funds this would indicate a substantial backlog of commercial property for sale. When you replicate this situation across the industry and take into account that UK banks are placing more and more pressure on customers with exposure to property, there is huge potential for a substantial increase in properties on the market. With little or no finance available for many potential buyers, those with cash in their pockets are calling the shots and literally forcing commercial property investors into distressed price asset sales.
Conclusion
While there is no doubt that the UK commercial property market will stabilise and improve in due course, 2009 looks as though it could be as bad as 2008 as the pressure continues to mount. While you have to feel some sympathy for investors in various property funds where redemptions have been suspended, property is and should be considered a long-term investment and such redemption suspensions, while highly uncommon, can occur.
Whether the growing number of property funds suspending redemptions has any impact on the long-term attractions of the sector remains to be seen although at this moment in time commercial property in the UK is friendless to say the least and set to struggle for the foreseeable future.