These may be exhilarating times for UK political commentators, but the uncertainty generated by the forthcoming “Brexit” referendum on UK membership of the European Union (EU) is an inconvenient reminder for investors of the illiquidity inherent in direct real estate and non-listed property funds.
UK commercial real estate markets have seen a marked slowdown since the start of the year as the forthcoming referendum has generated uncertainty amongst UK business space users and delayed decisions about leasing requirements. Similarly, the investment market has seen a reluctance among buyers to enter into big deals. In contrast, the trading volume of listed UK property stocks has been unaffected by the heightened risk in the run-up to the referendum.
Real estate investors often overlook or ignore the value of liquidity when investing in the asset class. Many are happy to take on the seemingly low volatility of directly held real estate or non-listed property funds and accept its lack of liquidity, when they step into the asset class. However, they can often be left ruing the decision when they want to sell their positions in buildings or non-listed funds. While events like the 23 June vote in the UK provide an unfamiliar setting for investors in real estate, they raise all too-familiar questions about the efficacy of investing in an illiquid asset.
The UK commercial real estate market has seen a marked slowdown since the start of 2016 as the referendum has generated doubt amongst UK investors and led to delays about investing. The investment market has seen a reluctance of buyers to enter into big deals, and preliminary figures from real estate agents Jones Lang LaSalle for the UK & European property investment market confirm a marked decline in activity in the UK in the first quarter of 2016. UK property market investment volumes were down 29% year-on-year, while Europe (including the UK) was down just 14%. The UK rental market saw no change in leasing transactions during the first quarter, but notably, the City of London saw a sharp fall in deals.
The lack of activity in the direct market contrasts with the flow of money into and out of listed real estate companies in the UK since the start of the year. Daily trading volumes in 2016 in the UK have been higher than for 2015 as a whole. The performance of listed and direct markets can be seen in exhibit 1 below. What’s clear is that listed real estate has been very sensitive to the forthcoming referendum, with the market down some 8% in the first quarter, under-performing Continental European real estate stocks by 10% (in local currency terms). In contrast, the IPD UK Monthly All Property Index, which measures the performance of direct property markets, was up 1.1% over the same period, as the selling in the UK listed sector in 2016 contrasted with the relative inactivity in UK direct property markets.
Exhibit 1: Return performance of UK property stocks, versus Eurozone property and UK direct property (IPD) in Q1 2016
Source: Bloomberg, as at 18 April 2016.
The slowdown in investment activity in direct markets is a perennial problem for direct and non-listed fund managers. It’s barely six years ago that in the aftermath of the financial crisis, property fund managers were closing their non-listed investment vehicles to redeeming investors as transactions in direct markets dried up. In 2008, 11 German property funds worth nearly €30bn were frozen to redemptions as major investors started to try and raise liquidity, prompting funds to stop redemptions as they were unable to sell assets to raise cash. Freezing of property funds was not just confined to Germany, as several UK property funds imposed restrictions. Liquidity problems were evident again in 2015, when a UK property fund was forced to suspend redemptions after large investors chose to sell their positions.
What’s happening on the ground in the UK property market year-to-date, confirms a key research finding we have discovered and are in the process of writing about in a white paper to be published in May 2016 explaining the reasons for investing in listed real estate. The research illustrates the limited liquidity of direct property compared to listed real estate.
The difference in liquidity was demonstrated by assessing how long it would take to sell a direct property portfolio and a similarly sized global listed real estate portfolio. The paper considers how long it would take to dispose of EUR 1 billion listed real estate portfolio consisting of the FTSE EPRA/ NAREIT Global (Developed) Index stocks under current market conditions compared to a direct real estate portfolio. It found it would take an estimated six to eight weeks to sell a direct portfolio in optimal market circumstances, around four months in normal market circumstances and more than a year in less favourable market conditions. In contrast, it would have taken just two days to sell 90% of the listed real estate portfolio and 11 days to dispose of it fully at the end of the fourth quarter 2015.
The European fund closures of the very recent past were an inauspicious token of the constraints of property’s liquidity. The fall-off in property investment volumes in the UK direct property market in the first quarter of this year should provide a further timely reminder for all investors of the illiquid nature of direct and non-listed property investing. The more curious real estate investor will unquestionably respect the potential that listed property’s liquidity offers while the more intrepid investor may be considering taking a position in the UK property market, despite a time of heightened uncertainty, because of the potential flexibility that owning listed real estate can offer. [divider] [/divider]
This article was written in Amsterdam and first published in the Weekly Intelligence Report on 19 April 2016