 "Are the UK property funds banning redemptions a precursor to crisis ahead?")
Real estate funds in UK are preventing investors from withdrawing their money in the aftermath of the Brexit vote. After the British community voted in favour of exiting from the European Union, two asset classes in the UK have been hit. The first is its currency, the sterling, and the second is the real estate market.
Around 18 billion pounds ($23.4 billion) invested in real estate funds were frozen after investors rushed to them for redemption in the aftermath of Brexit.
The British pound has fallen to a 31-year low after the referendum, falling over 13% against the dollar and traded at 1.28 for the first time since 1985. Chief Economic Advisor to Allianz Mohamed El-Erian said that he feels that unless the government acts rapidly to control the situation the pound could touch parity against the dollar.
Investors feel that Brexit will result in businesses exiting from the country thereby resulting in lower demand for real estate. Market expectation is that real estate prices in the country will correct by over 20% over the next three years.
Stopping redemption is however, not the answer as it will lead to more panic which can spread to other asset classes. Bill Gross of Janus Capital equated the chain of events to the previous financial crisis says “It’s reminiscent of Bear Stearns’ subprime funds before the Lehman debacle. The system doesn’t allow liquidity to flow into the proper places. If these property funds are just one indication, perhaps there will be others to follow. I think it’s something to worry about.”
Investors feel betrayed not only with the manner in which they are being prevented from withdrawing their funds, despite the investments being in open ended funds but also in the sudden depreciation in the value of their holding. Aberdeen Fund Manager’s Ltd, the seventh fund that has halted redemption cut the value of its property fund by 17%. Legal and General Plc said it is adjusting the value of its 2.3 billion pound property fund by an additional 10%.
Britain had seen similar banning of redemption in 2007-08 when prices corrected by 40%.
Real Estate funds are not as liquid as equity or bond funds. Though these funds keep anywhere between 15-20% in cash to meet redemption pressure, any sharp increase would mean selling their assets to generate cash. Selling real estate requires time and when the market knows funds are facing redemption pressure, buyers tend to disappear. Out of the 24.5 billion pounds invested by various funds over 18 billion pounds investment are frozen.
The key question, though, is: Will the contagion spread to other markets?
Thankfully world markets learnt some lessons from the previous crisis. A research note from Bernstein says that ‘Banks haven’t really played the asset class in the last five years – it’s mostly been shadow banking sector’. British banks hold 90 billion pound of the 183 billion pound commercial property loan market at the end of 2015.
Banks are the common thread among various asset classes. By limiting the exposure to the sector authorities have been to some extent able to succeed in keeping the crisis restricted. Bank of England Governor Mark Carney said: "One of the things the PRA (Prudential Regulation Authority)has done over the years is to ensure that the exposure of UK banks to commercial property has been kept quite manageable…This (Brexit fallout) is not a big issue for UK banks" he added.
Little wonder then that equity markets in the UK are moving higher confidently.
Around 18 billion pounds ($23.4 billion) invested in real estate funds were frozen after investors rushed to them for redemption in the aftermath of Brexit.
The British pound has fallen to a 31-year low after the referendum, falling over 13% against the dollar and traded at 1.28 for the first time since 1985. Chief Economic Advisor to Allianz Mohamed El-Erian said that he feels that unless the government acts rapidly to control the situation the pound could touch parity against the dollar.
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But governments across the globe seem to be working at their own pace. UK’s foreign secretary Philip Hammond said "For the moment we are not in a position to begin substantive negotiations immediately". Uncertainty is something that markets have always detested. It is exactly this uncertainty that has hit the real estate market in the UK.
Investors feel that Brexit will result in businesses exiting from the country thereby resulting in lower demand for real estate. Market expectation is that real estate prices in the country will correct by over 20% over the next three years.
Stopping redemption is however, not the answer as it will lead to more panic which can spread to other asset classes. Bill Gross of Janus Capital equated the chain of events to the previous financial crisis says “It’s reminiscent of Bear Stearns’ subprime funds before the Lehman debacle. The system doesn’t allow liquidity to flow into the proper places. If these property funds are just one indication, perhaps there will be others to follow. I think it’s something to worry about.”
Investors feel betrayed not only with the manner in which they are being prevented from withdrawing their funds, despite the investments being in open ended funds but also in the sudden depreciation in the value of their holding. Aberdeen Fund Manager’s Ltd, the seventh fund that has halted redemption cut the value of its property fund by 17%. Legal and General Plc said it is adjusting the value of its 2.3 billion pound property fund by an additional 10%.
Britain had seen similar banning of redemption in 2007-08 when prices corrected by 40%.
Real Estate funds are not as liquid as equity or bond funds. Though these funds keep anywhere between 15-20% in cash to meet redemption pressure, any sharp increase would mean selling their assets to generate cash. Selling real estate requires time and when the market knows funds are facing redemption pressure, buyers tend to disappear. Out of the 24.5 billion pounds invested by various funds over 18 billion pounds investment are frozen.
The key question, though, is: Will the contagion spread to other markets?
Thankfully world markets learnt some lessons from the previous crisis. A research note from Bernstein says that ‘Banks haven’t really played the asset class in the last five years – it’s mostly been shadow banking sector’. British banks hold 90 billion pound of the 183 billion pound commercial property loan market at the end of 2015.
Banks are the common thread among various asset classes. By limiting the exposure to the sector authorities have been to some extent able to succeed in keeping the crisis restricted. Bank of England Governor Mark Carney said: "One of the things the PRA (Prudential Regulation Authority)has done over the years is to ensure that the exposure of UK banks to commercial property has been kept quite manageable…This (Brexit fallout) is not a big issue for UK banks" he added.
Little wonder then that equity markets in the UK are moving higher confidently.