Q4 cap rate trends

Property funds possess stabilizing mechanisms

Analysts project capital will shift to real estate
Monday, March 23, 2020

REALPAC’s recent survey of 15 Canadian open-end real estate funds offers insight into when and why fund administrators would suspend the ability for investors to redeem their holdings. It’s a step that some property funds based in the United Kingdom have taken as the COVID-19 outbreak triggers economic uncertainty and market volatility. Twelve of the 15 Canadian funds have the same ability to deploy redemption gates.

“The ability to gate or suspend redemption is an important mechanism that general partners have to address a possible max exodus at a time that may have long-term repercussions for the fund,” accompanying commentary from REALPAC states. “Redemptions can be suspended, and have been numerous times globally, for a variety of reasons including market closures, cyclones, cyber-security incidents or difficulties in valuation of certain assets at a time of significant redemptions.”

Most recently, U.K. based property funds also suspended redemptions in the days following the June 2016 Brexit referendum results. The 2008 financial collapse and the September 2001 terrorist attacks in the United States have similarly spawned suspensions.

“The use of this mechanism is often to curb a possible contagion in the affected sector and diminish the impact it may have on financial stability,” the REALPAC commentary clarifies.

The investor profile revealed in REALPAC’s survey results is one heavily weighted to institutional investors. That’s unsurprising since open-end funds — private investment vehicles that typically hold long-maturity income-generating assets and allow for contributions and withdrawals on an ongoing basis — are considered well matched to investors with long-term needs for stable, predictable returns.

The 15 open-end funds responding to REALPAC’s survey report a varying schedule for, and limits on. redemptions. However, conventionally, it’s not a routine practice for investors. Just six funds reported redemptions in the three years of 2016 to 2018.

Five funds provide a quarterly window for redemptions, while four funds allow monthly redemptions and three permit daily redemptions. Alternatively, two funds restrict it to a onetime annual opportunity, while the remaining fund applied the specifics outlined in the limited partnership agreement.

More than half of the Canadian funds set no threshold for the value of withdrawals. The other seven reported seven different formulas for allowable redemptions, including stipulated percentages of net asset value (NAV), assets under management (AUM) or the requesting limited partner’s own holdings.

Meanwhile, new analysis from Colliers Canada concedes that economic prospects have altered dramatically in the past few weeks, but concludes that real estate is better poised than many investment asset classes to weather the storm. Rather than fear of investors checking out, analysts expect to see them eventually migrate to the sector. They cite the recent slashing of interest rates, real estate’s track record as a stable asset in times of turmoil and heretofore Canadian market fundamentals as reasons for guarded optimism.

“In particular, weak expected returns in many other sectors should drive capital to commercial real estate (both direct investment and public real estate equity) and the low interest rates should allow investors to lock in favourable financing rates to expand their real estate portfolio,” the Colliers report projects. “Given the recent strength of the underlying fundamentals of the Canadian commercial real estate market, it is anticipated the effects of COVID-19 on the market will be temporary and significantly shorter than those of past financial credit crises.”

That said, some hurdles are foreseen in the interim. “First among the concerns are the short- and long-term impacts the pandemic could have on underlying property fundamentals and returns, including constraints in supply chain, consumer spending, business investment, hospitality and international trade,” the Colliers report tallies.

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