Over the last few weeks, real estate fund managers and investors have experienced a rollercoaster of emotions as markets responded to events at a velocity far in excess of anything Alton Towers has to offer. There has been significant volatility but what might the long-term effects be and how can stakeholders prepare for whatever is next?
What has happened and why?
Long before the tumultuous economic events following the mini-budget of 23 September, the UK economy faced various challenges – inflation rising; interest rates going up; the economy and retail demand slowing. In the lead-up to the events of late September, we had yet to really see the full impact of these issues in the real estate sector. The market seemed a bit slower than usual – a consequence perhaps of the summer break and the passing of the Queen.
In the immediate aftermath of the mini-budget, a particular crunch point loomed for defined benefit pension schemes as they required significant cash as collateral in a short space of time. Another consequence was investors in real estate funds rebalancing their portfolios as bond valuations fell.
One of the ways to raise this much-needed cash or rebalance portfolios was to redeem interests in open-ended real estate funds, but as was seen post the 2008 Global Financial Crisis, it is not always easy to exit open-ended real estate funds when others want to as well, due to the inherent illiquid nature of the underlying assets.
What we saw was pension funds selling off easily tradable assets quickly to meet margin calls linked to hedging positions, but then having to sell other positions that had not fallen and in which they were overallocated. This is the “denominator effect” i.e. the value of one part of a portfolio falls sharply and pulls down the value of the overall portfolio, resulting in those segments of the portfolio which did not decrease representing a larger percentage of the overall portfolio.
What happens next (possibly)?
Many have long since given up on trying to predict what may happen in response to fast-changing conditions (and this article has been rewritten on at least three separate occasions as positions move 180 degrees), but here goes:
- As uncertainty continues, investors delay investment decisions, leading to difficulties accessing capital for deals.
- Managers raising new funds need to have a very specific focus and expertise to raise capital in the near term. That said, TPG recently raised more than US$6.8 billion for their fourth opportunistic real estate fund investing in the US and Europe, so it is not all bad.
- Dislocations in the market present opportunities for funds still in their commitment period with funds to be drawn.
- The strength of the dollar coupled with decreases in the valuation of domestic real estate make the UK attractive for overseas investors, notwithstanding other economic challenges such as high interest rates and energy problems. As the appetite for some investors falls, others may see this as an opportunity to strike for trophy assets.
- Some open-ended real estate funds will continue to limit redemptions as pension fund investors look to reduce their real estate exposure. This was starting to be an issue prior to the mini-budget. The rules around open-ended funds investing in illiquid assets have been under review since the 2016 Brexit vote (really), but a final decision is still awaited. The proposal is for mandatory notice periods, but that has not received universal backing.
Challenging but interesting times lie ahead.
