Managers with funds due for termination are choosing to extend rather than liquidate. But are investors happy to tie up their equity for longer in the hope that the market will improve? Shayla Walmsley reports
Property investors have one motive for selling in a market characterised by falling capital values: because they have no choice. So it should come as no surprise that, according to a study published in October 2008 by INREV, fund managers are choosing to extend the lives of their funds rather than liquidate them and dispose of their assets.
Of the 45-strong, €30bn universe of funds scheduled to terminate in 2008-10, the INREV Fund Termination Study 2008 found that, in contrast to the previous year, when 52% of fund managers planned to terminate, almost 60% are now planning to continue the life of their funds by either extending them (78%) or rolling them over (22%).
What surprised the authors of the report is that opportunity funds are catching up with core funds in their intention to extend. In the past, INREV points out, opportunistic funds have tended to opt for liquidation over extension. Yet in the recent study 43% planned to continue their funds in a bid to avoid selling in the current market.
"Core funds have more of a long-term tendency," says INREV's director of research and market information Andrea Carpenter. "Investors tend to see them in terms of their long-term strategies. Opportunistic funds speak to their business plans - they're focused on returns. There is some flexibility about how to exit - from investors and fund managers. Neither side wants to be forced to sell."
For both core and opportunistic fund managers, extensions of one or two years offer a temporary reprieve on the decision whether to sell assets - with the hope, of course, for better pricing in the market in the meantime. Although the investors interviewed by INREV were more likely to be fund managers than pension funds, there is clearly some recognition on both sides of market realities.
Jörgen Österberg, investor relations manager at Sveafastigheter, one of the survey participants, says that the fund manager only has one fund close to termination, and that it has already sold most of the assets. "Lots of funds are in a position where they have to consider a rollover or an extension because the market is forcing them to do it. Investors in those funds don't really have a choice," he says.
But there are caveats to this putative alignment. "If you're now in an exit situation and asking investors whether they want to close down the fund, lots of investors will take the money," says Oliver Brazier, managing director of FREO, the German fund manager, which recently closed a €161m five-year opportunistic fund with two one-year extension options. "But in five years, who knows?"
He adds: "In general, investors don't like clauses that allow fund managers to extend the fund. Every group of investors is different but we've discussed it in great detail, and investors trust us. In any case, we are at the start, so that problem doesn't really apply to us - the bottom-line issue for investors now is to be careful with the money. The market is good for us. If I were at a different stage I might be more nervous."
It is easy to see why pension scheme investors in funds would be reluctant to mandate extensions in a less extraordinary market. For the highly liquid, it is less of a problem. Strong liquidity enables the £8bn (€10bn) West Midlands pension fund to ride out market downturns without becoming forced sellers, for example. It also awards the scheme, which selects fund managers for real estate and other alternatives via an in-house team rather than relying on consultants, a degree of flexibility.
"In our view, if good managers are choosing to delay some investments due to market conditions or indeed are finding interesting opportunities which may involve extending a fund, then we are happy to back their judgement," says chief investment officer Judy Saunders. "This reinforces our long-term approach to investing."
But there is a principled reluctance mixed in with the realism. Michael Nielsen, head of ATP Ejendomme, the real estate subsidiary of the €46.9bn Danish supplementary labour market fund, describes non-termination as "absolutely the last solution". Yet he acknowledges that, in the current market, needs must.
"If termination means starting to sell off all the properties in a fund, it's not the right time to do it if it means the fund manager will have to fire-sale all his properties. It will have a huge negative impact on the values and the return to investors. In that case, it is most realistic that we would vote for an extension."
Where the scheme does agree to an extension, the shorter the better. "Of course, we would prefer shorter extensions - say, for a year, then take it up again after that time," says Nielsen. "I'm not sure we'd extend the manager's mandate for another five years - that's too long. When we enter into a closed-ended fund, it's the whole business case to terminate it at the right time. If the right time is after two years' extension, we will terminate it then. We want to be sure that the manager is focused on the right time to exit."
Back in 2006/07, pricing made asset disposal attractive - though, as the INREV report points out, it also encouraged some managers to extend funds in the hope of matching disposals with peak prices. Now, despite the reluctance to dispose of assets at below-par prices, extending vehicles is hardly an easy option.
In fact, the need to refinance at greater cost may put pressure on funds to liquidate rather than extend - even if it means disposing of assets at less than optimal prices. Tony Smedley, head of European funds at Invista, describes refinancing as "the main event" when the existing loan facility for its European property fund came up for expiry at the end of the year.
"It looked in the summer that finding a new bank would be the least expensive option but, as the market seized up, it was impossible to get new finance," he says. The fund manager - which has begun selling off assets - needed €400m, but found banks were willing to offer at most €50m or €100m. Instead, it renewed its existing facility with the Bank of Scotland, which owns 55% of the fund manager. "It was more expensive, but it was a good result for the fund," says Smedley.
In this case, investors in the fund backed the decision. "They saw it as the best result for the company because there was certainty of funding." It is arguably because of this realistic approach on the part of fund investors that the mass forced sale of liquidated funds' assets has not materialised.
"There is more resilience in the market than you would think," says Nick Axford, head of research at CBRE. "Everyone is surprised that there are not more forced sellers. Some observers are overly optimistic, some overly pessimistic - they're expecting Armageddon, but it won't arrive. There is a degree of expectation of forced sales but there are, in fact, very few forced sellers.
"If we see some, it won't trigger a huge slide in market sentiment. It's like watching two people that you've seen get together, live together for a long time and have children; then they suddenly announce their engagement. You think ‘OK', but there's no huge outpouring of euphoria and emotion."