Can a growing confidence in a wider economic recovery be read from the reasons funds give for termination in the most recent INREV study? Lonneke Löwik reports
The first European Association of Investors in Non-Listed Real Estate Vehicles (INREV) Fund Termination study in 2006 showed that terminations of non-listed closed-ended real estate funds in the INREV Vehicles Database would peak between 2007 and 2010. That initial study, in what is now a bygone economic era, found that extensions were the most likely termination option, driven largely by satisfaction with current portfolio compositions and returns.
Every year since then, and again in 2010, INREV has investigated the options that fund managers consider as closed-ended fund termination dates approach, along with the impact changing market conditions have on termination decisions. These studies have taken place in volatile and contrasting economic circumstances.
After a long period of steady growth and widely available capital and debt financing, markets peaked in 2007 and the ensuing financial crisis caused real estate values to decline, financing became unavailable and the resale market ground to a halt. The most recent fund termination study took place in a more favourable economic climate in May and June as markets had already started to show tentative signs of a recovery.
Not surprisingly, each of these phases in the market cycle has had a major influence on the strategies funds adopt for their termination. After the widespread preference for extension that was seen in 2006, when many investors were satisfied with the portfolio composition and return, the 2007 study showed that during the market peak in many European countries, liquidation became the most common termination option as fund managers aimed to time the exit point as as closely as possible to the market peak.
In 2008 and 2009, as market conditions rapidly deteriorated, extensions again became the preferred fund termination option, but that preference was driven by a completely different motivation than that of 2006. Fund managers were anxious to avoid liquidating funds at the bottom of the market, preferring instead to delay liquidation until market conditions improved.
In 2010, the study based on information provided by 39 closed-ended funds in the INREV Vehicles Database with a total of €24.6bn shows that continuing a fund remains the most likely strategy for funds terminating within the next three years. In fact, just under half of the funds terminating between 2010 and 2012 are now planning to continue the life of the fund; 36% by extension and 13% by roll-over.
However, liquidation is again becoming popular as markets have started to improve in some European countries. In a new development this year, for some core funds, the sale of the fund or merger with another fund is an option under consideration, along with possibly going public through an initial public offering (IPO) in a few cases.
The study sample included 10 core, 17 value added and 12 opportunity funds and in some ways the study results reflect this weighting towards fund styles higher on the risk-return spectrum, as some significant differences in fund termination options and final decisions can be seen among fund styles. For example, value added funds are nearly two times more likely than core funds to consider liquidation as an option. At the same time, a significantly higher percentage of value added funds than core funds that had already selected a planned fund termination elected to extend the fund. Core funds that had already made a termination decision opted to roll over in much greater percentages than either value added or opportunity funds, while opportunity funds that had already made a decision about fund termination were equally split between liquidation and extension.
Debt and refinancing issues continue to be important in termination decisions for funds due to end on or after 2010, but declined significantly in overall importance compared with last year's study. This result may reflect improved availability of financing despite the higher cost of debt on average and a degree of success to date in dealing with the debt issues. It might also reflect either improving capital values, which result in more assets having their heads above water, or the first signs of fund manager optimism about a possible economic upturn which could improve refinancing options.
For investors considering continuing a fund, fees is also a major issue. In response to the survey, investors stated that they believe fund managers should be open to renegotiation of fees, but a number of fund managers indicated this would be unlikely except in cases where the decision to continue a fund requires investor consent or new fund terms.
The market turbulence of recent years has had other interesting results on fund terminations. It has led to earlier discussions and, in some cases, also to earlier decisions on terminations.
Starting discussions on fund terminations early allows fund manager to have detailed consultations with their investors and to determine the best possible termination or continuity plan for the fund for all parties involved. More time also allows fund managers to prepare to negotiate refinancing options in case of extensions or to develop sales strategies in case of liquidations, which survey participants noted take longer in the current down market than in an up market. However, an increasing percentage of respondents with funds terminating this year or next indicated that they were postponing the actual decision on fund termination until closer to the end of the fund life in order to gauge and react to market developments.
Investors participating in the INREV survey commented that some options, such as roll-overs, typically require new fund terms that need the consent of the majority of the investors, which can also be time consuming, if it is even a viable option for some funds. In addition, while some investors with a longer investment horizon might be open to continuing the life of a fund, liquidation is generally the default option for closed-ended funds and, without the consent of the majority of investors to continue the fund, it would be forced to liquidate.
It will be interesting to observe how these decisions are made in the months ahead, influenced in no small part by how quickly and to what degree markets continue to recover.
Lonneke Löwik is director of research and market information at INREV