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Immovable objects

The FSA may have to backtrack on its ruling to allow property funds to hold 100 per cent in direct property after the swathe of redemptions that has hit this market in the past few months proves just how important a buffer of liquidity is in such vehicles.

As part of the transfer to the FSA’s Coll sourcebook in 2006, open-ended funds were allowed to invest 100 per cent of their assets in direct property. Until then, managers were required to have at least 20 per cent in liquid assets to meet redemptions. But that 20 per cent liquidity was seen as potentially diluting returns and some argued it put UK funds at a disadvantage to offshore funds as they could invest 100 per cent in direct property. So last year the FSA consented and funds moved their prospectuses to allow for the ability to hold greater amounts of property.

Luckily, they never got the chance. Despite being able to invest 100 per cent in immovables, as they are referred to in the FSA regulations, few funds, if any, actually made it to this point as the wall of retail money entering this sector prevented them from being fully invested. That has turned out be a good thing as that available liquidity has helped keep retail property funds from having to suspend dealing due to being unable to meet the more recent wall of redemptions.

Mike Hannigan, investment director at Standard Life Investment property, notes that outflows from retail property funds have been higher than the indus-try could have anticipated. He agrees that some funds have become active sellers of assets but does not think managers have become forced sellers of property to keep up with redemptions. He attributes some of this to the liquidity levels that most of them had when the market started to turn.

Jeremy Soutter, head of product development at Morley, believes the FSA should reconsider its stance on a direct property cap, especially in light of what is being considered at the European level. He points out the European Commission is examining ways to make property fund structures more accessible and a cap on immovables is being widely considered. If that goes ahead, the FSA might well have to follow suit.

Although retail funds have not had to suspend dealing, there is no denying the difficulty these portfolios have had in recent months, leading to concerns that yet another generation of investors could have been burnt by overexuberance in a single asset class.

New Star is the latest property provider to make headlines, having revalued its fund down by 8.2 per cent. In November, M&G restricted redemptions from its property fund and the Invesco property income trust saw its share price fall by 56 per cent in one month and has struggled with its gearing position. Its discount has widened to 70 per cent, according to Trustnet figures. AIC figures have gearing levels on property trusts ranging from 0 to 78 per cent, so the Invesco trust may not be the only one to have gearing issues.

The falls in the UK comm-ercial property market are the worst in over 15 years and November saw one of the worst falls ever recorded in the commercial property IPD index, down by 3.6 per cent.

David Skinner, head of property research at Morley, expects valuations to continue to fall into the new year before starting to stabilise.

He notes the speed of the falls could work in favour of the asset class as it has maintained investor interest. “I do not think that buyers have gone away, they are waiting until the pricing becomes attractive again,” he says.

Hannigan says: “We are in the middle of a very dramatic correction but it is not a property crash.”

Both Hannigan and Skinner feel the first half of next year will see a return of fortunes to the asset class.

Hannigan notes that retail investors can be behind the curve when compared with the buying trends of institutional investors, he thinks it will be interesting to see what those intermediaries who were early in their recommendations to quit funds do in the future.

Already, the discounts being seen in open-ended funds (being on a bid basis) and closed-ended, could be seen as attractive to those who believe in the longterm story of the asset class. According to Cofunds, while Property was the best seller for the first six months of 2007, net sales were down to zero by the end of November. Property investment trusts, which were trading at premiums to NAV not so long ago, have all moved to deep discounts – an average of more than 33 per cent.

Whether or not the falls of recent months will have scared away retail investors once again will remain to be seen.

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