What the FCA document means for real estate funds

The real estate market may have opened up after the lockdown, but when it comes to open-ended real estate funds, these are still firmly closed.

Investors cannot request redemptions or make new investments in these funds.

It’s a situation that prompted the regulator to launch an investigation into this development, which has now occurred three times in the past 20 years – mostly in recent years.

As a result, the FCA released consultation document CP20 / 15 on August 3, 2020, seeking industry advice by November 3, 2020 on what should be done.

In that consultation paper, the FCA hinted that it was considering removing the daily trading facility for these funds and replacing it with a 90-180 day notice period for redemptions.

The initial comment in the dispatches focused on the fact that this would make the funds ineligible for Isas, and could also cause problems within self-invested personal pensions, leading some to suggest that they should be liquidated.

However, before these investment vehicles are scrapped, it is a good idea to also look at the reasons why investors, professional and private, have invested in the past.

The fact that these funds are structured as Non-Ucits Retail Schemes means that they are subject to fewer restrictions than Ucits funds.

Commercial real estate as an asset class first entered the dominant retail investor universe in the 1990s. Many were started by asset managers of insurance companies, with a portfolio of assets ceded to life insurance funds to produce a retail product accessible to the general public.

They were greeted with open arms as they offered the small investor a way to gain exposure to an uncorrelated asset class that was different from stocks, bonds and cash, aside from insurance coverage- life.

Many commentators strongly believe that the only structure that should be allowed for exposure to retail commercial real estate should be a closed-end investment trust, where buybacks simply involve the sale of shares and do not potentially trigger a sale of assets.

The share price of the investment fund will simply fall to a discount to the net asset value and the fund manager does not need to disrupt his portfolio for redemption reasons.

Different sectors, different performances

However, this point of view misses an important point. Open-ended commercial real estate funds have very little influence on short-term movements in the equity market, or bond markets for that matter.

The value of the underlying assets depends on the aggregate demand for commercial goods, whether office, warehouse, retail or industrial.

This is driven by economic growth and the prosperity of companies wishing to occupy premises. The valuation of a property is influenced by this commercial demand but also by the quality and location of the property and the yield or rent achievable in the locality.

While there is a link with the economy at large and therefore a cyclical nature, there is also a secular longer term link with the economic prospects of the main type of tenant.