UK property sector begins to wobble
W&D readers well know that it wasn't the collapse of Lehman Bros in September 2008 that presaged the GFC.
It was 15 months earlier (June 2007), when Bear Sterns, another US investment bank, prevented investors from withdrawing cash from two mortgage-related hedge funds. By July 2007 both funds had collapsed.
The rot that became the GFC had started.
W&D fast-forwards to now. Global interest rates have been very low. And so investors have been looking for alternative places in which to invest to get a higher yield or higher income than that offered by bank deposits. Property trusts seemed like a fine idea.
So prices went up, yields went down and a sense of overvaluation arose. Six months ago the august Bank of England warned about this. And then along came... Brexit. And last Monday the BoE said that commercial property was one of the five main risks following Brexit.*
A handful of UK unlisted property funds have marked down the value of their property holdings by 5%. This exacerbated fears that Brexit will cause a general fall in property prices, and hence investors, lots of them, want to get their money out.
Hold the phone! Property funds cannot sell assets quickly to raise cash to meet large redemption demands.
And so this week, six UK property funds (including the largest and third largest) have frozen redemptions for at least 28 days. These six funds make up more than 50% of the UK's £25 billion property investment sector.
But wait, there's more. Another large fund (Aberdeen Property Trust) decided to keep paying redemptions, but discounting the value of its investments by 17%. So, the value of its investments fell by 17% at the stroke of a pen! Good grief. Those canny Scots know how to keep things tight.
Watch the dominoes start to fall. The forced selling of buildings by investment funds could act as the catalyst for a steep drop in commercial property prices, as happened during the GFC.
W&D is not suggesting a parallel to the Bears Stern funds that collapsed - those funds were invested in mortgage derivatives. The six UK funds are invested in bricks and mortar, as it were.
But they are unlisted, and promise to hand-back capital at a fixed price (based on historic net asset value). Which causes the liquidity problem.
So these funds have a design problem. Ignoring that, for a moment, W&D reminds readers that even the price of bricks and mortar can fall. In the GFC, Australian property trust prices fell by over 70%.
Here we go again.
*The five are:
- UK's large current account deficit
- UK's commercial real estate market
- high UK household debt
- subdued global growth
- 'fragilities' in financial market functioning
W&D senses that the BoE had an in-house competition to create a new word for the week. The aim is to insert that word into an official document and see if anyone notices. The winner was 'fragilities'.