Amongst a sea of economic and political uncertainty post Brexit, ‘extraordinary market circumstances’ have now caused the open-ended Aviva, Standard Life & M&G commercial property funds to suspend redemptions. Henderson is mooted to follow.
The last time Standard Life made such a move was during the Global Financial Crisis (GFC) in 2008, in a similar act to safeguard investors. As one senior analyst has said: “The problem these funds face is that it takes time to sell commercial property to meet withdrawals, and the cash buffers built up by managers have been eroded by investors heading for the door.”
LCP advised one of the best performing funds during the GFC. Its London Central Portfolio Property Fund returned a 7.5% annual IRR after all fees, costs and taxes. Commenting on the suspensions, the company say investors should now, once again, be looking away from commercial funds and focusing on residential opportunities. LCP has just announced a 3-week extension to buy shares in its latest listed residential property fund, London Central Apartments III (LCA III), which invests in mainstream Private Rented Sector in Prime Central London (PCL).
CEO of LCP, Naomi Heaton, explains: “Commercial funds tend to invest in large trophy assets reliant on a small pool of tenants whose future depends on the well-being of the UK economy. Experience from the GFC demonstrates that when the economy dips, these funds are left with squeezed income yields and non-performing assets, difficult to dispose of in a softer market. Residential funds are dependent on a much broader tenant base, mitigating any increased levels of tenant turnover. During the GFC, LCP’s managed portfolio maintained full occupancy, despite job losses of up to 33% in the City. Residential funds, such as LCA III, are also spread across multiple highly liquid assets with potential to be readily traded.”
Investors should also beware the empty promises and liquidity trap of open-ended vehicles, adds the company, and learn the harsh lessons of the GFC.
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“Whilst open-ended funds, such as Aviva, purport to offer liquidity, in a falling market these funds suspend redemptions when investors rush to withdraw money, with disastrous consequences. Closed-end funds do not have this problem as investors come in with a medium term horizon and do not bank on a speedy exit.”
LCP not only has experience of advising funds during the GFC, it has a strong track record of ‘calling the market’. It launched the London Residential Recovery Fund in early 2009 when all other commentators predicted a further slump in prices, of up to 30%. LCP, on the other hand, predicted a significant market rally and its fund is returning an annual IRR of 13.5%.
It is LCP’s view now that despite the negative sentiment currently surrounding the UK economy, PCL offers a strong upside. It anticipates that the market will respond to Brexit in a similar way as it did following the GFC when prices surged, underpinned by a weak pound and low interest rates.
This is likely to be at variance to the housing market in the rest of the country, as well as commercial property funds, which are far more susceptible to a domestic economic downturn. It is LCP’s view that LCA III’s ‘buy to let’ strategy in PCL will be far more robust in the forthcoming years than the ‘build to let’ models that focus on the less prime areas of London and the rest of the country and which target the domestic market.
Just as during the GFC, it will be Prime Central London which is likely to show the most resilience, benefitting from international investment and international tenants, rather than depending on the domestic market and a weakening domestic economy.
Heaton concludes: “Against a backdrop of volatility in equity markets and instability for commercial property, it is probably fair to say that LCA III is one of the best positioned investment vehicles to benefit from the opportunities that now present themselves. Coupled with the significant tax advantages that the government has offered property funds with Genuine Diversity of Ownership, investors coming into the new fund now will certainly be ahead of the curve. As we stated in 2009 ‘it is the early bird that will catch the very fat worm’”