Commercial property has taken a battering since the UK electorate voted to leave the EU last month, emerging as the weak link in the UK financial sector.
Approximately 7% (£35 billion worth) of investment in the UK commercial property market is invested in commercial property funds.
These allow the public to invest in commercial properties, such as shopping centres and office blocks, that would usually only attract investment from professional investors.
In the days following the leave vote, three funds were suspended and more are expected to follow suit in the coming weeks.
M&G, part of Prudential, stated that it has seen a “marked increase” in customers looking into leaving the portfolio and all three have said that investors will be better protected if they prevent further commercial property redemptions.
These moves from major insurers sparked fears of forced selling becoming the “catalyst for a steep drop in commercial property prices” reminiscent of the 2008 economic downturn, according to the Financial Times.
Why are they closing?
In the weeks leading up to the EU referendum, many investors anticipated that leaving the EU would reduce the price of commercial property and withdrew their money from commercial property funds.
Recent data from the Investment Association shows that in total, non-professional investors withdrew £360 million in May.
Commercial property is a difficult asset to sell in a short space of time so these large-scale withdrawals have caused problems for funds that cannot pay investors back immediately.
In a bid to ease these problems restrictions are being put in place so that fund managers have adequate time to sell properties, rather than being forced to sell quickly at a very low price to put money back into investors’ pockets.
Selling quickly and at fire-sale prices would have a domino effect, driving down the value of funds and encouraging more investors to withdraw.
Eduardo Gorab at Capital Economics said: “By limiting redemptions, funds would allow the uncertainty surrounding the UK’s political and economic environment to recede. In turn, this could stem fire sales, limiting the discounts at which funds would have to sell their holdings.”
Will more funds follow suit?
There is a possibility that other funds will follow suit. However, chief executive of the Financial Conduct Authority, Andrew Bailey, suggested these withdrawals should be seen as a sign that the market is working correctly rather than reflecting a state of panic, and that suspending funds is “designed into the structures to deal precisely with that situation where there’s been some shock to the market”.
Not all property funds are closing their doors on redemptions. Legal & General currently has no plans to stop investor withdrawals, insisting that “the fund retains over 20% of its net asset value in liquid assets, the majority of which is held in cash.”
Laith Khalaf, senior analyst at Hargreaves Lansdown, said: “Clearly, there has been a knee-jerk reaction to Brexit in the commercial property sector, which may moderate over time. Investors in commercial property funds should not make decisions in a panic.
“Granted the Brexit vote may have the potential to negatively affect the commercial property market in the short run, but long-term investors should be willing to ride out periods of weakness, particularly when there has been such a sharp decline in fund prices without much evidence of a slowdown in the underlying property market."
What are the banks doing?
The heightened uncertainty associated with an exit from the EU has highlighted the problems with promising instant payback to investors when selling assets, such as commercial property, that are difficult to sell in a hurry.
The Bank of England has conducted ‘stress tests’ on banks to make sure that they can withstand a 30% fall in property prices. This year’s stress tests will be inclusive of another shock in prices.
