Kempen Real Estate Update: Barbarians at the gates
A recurring and important question regarding all shapes and forms of prudent investing across all asset classes and instruments is “how do I get my money back?”. Whereas larger institutional investors may have the luxury of investing with nearly perpetual time horizons, for retail investors and institutional investors with stringent spending requirements (foundations, endowments, insurance etc..), this question is of the utmost importance as often they do not have this luxury option. With the recent suspension of trading in two UK property funds and US ODCE funds due to a sustained increase in redemptions at the end of 2019 (also known as gating), we explore this topic further and look into how investors can avoid being caught in gated property funds.
Real estate is continuing to gain in popularity as an asset class and especially more so in the current “low bond yield/expensive general equity markets’’ world as it can offer a happy medium of a risk/return profile in between the two aforementioned asset classes. Given the continuing global investor yield starvation and the promise of participation in a continued economic recovery (via growing rents and occupancies), it is not difficult to see why increasing allocation to real estate makes sense both for private individuals, retail investors and for institutional investors. During 2019, the top ten global institutional investors have increased allocation to real estate to an average of c.19% of their overall portfolios or representing a total of c.$1,000bn1, a meaningful amount.
Whilst there are various ways of tapping into the real estate markets and benefiting from its investment characteristics, listed real estate companies offer some unique advantages. It is our view that broadly speaking in a historical context REITs exhibit equity like returns in the shorter run, getting somewhat affected by the general equity markets noise. We believe that over the investment horizon of eighteen months or longer, listed real estate behaves more like the underlying real estate than the equity markets which is logical, as at the end of the day, REITs own and manage the bricks and mortar. However there are variations due to: first and foremost the capital allocation strategy of the management team , the level of debt employed in the business, and the ESG structure of the vehicle (alignment, externally/internally managed etc…).
Zooming in on the previously mentioned issue of the suspension of trading in open ended retail property funds in the UK and large redemptions in the ODCE funds across the pond, the impact was worrisome. The “gating” of the funds late last year was caused by Brexit uncertainties and, to our view, structural retail real estate issues which were not pro-actively addressed by the managers when things started to unfold. One fund even had to suspend redemptions twice over the last four years. On top of that, the UK regulator requires open-ended retail property funds to provide daily liquidity which could cause a mismatch between the liquidity of the direct assets and the liquidity offered to the end investors. Managers generally keep certain cash levels to deal with regular redemptions.
“Herding behavior may exacerbate unnecessary volatility and add a systemic risk to well-functioning capital markets. This can be troublesome for the market in general, but it can also create opportunities for sharpshooters.”
These property fund redemptions across all UK managers totaled nearly £1.5bn2 during 2019, an alarming number. Whilst buying and selling during volatile times of geopolitical uncertainty is not unique to real estate or to open-ended property funds, the incentives it provides are. Much of the reason why these funds couldn’t raise the necessary cash was due to the lack of liquidity in some of the underlying troublesome retail buildings (shopping centers as well as high-street retail assets) which are suffering from the extremely strong e-commerce penetration rate of c.22%3 in the UK. It takes time to sell a building and in times of distress prices can drop to largely suboptimal levels. One would expect an experienced manager to be able to pro-actively rebalance their portfolio away from weakening sectors/areas in an attempt to generate attractive returns for its investors. Worse yet, if cash is urgently needed then the manager may be incentivized perversely towards the path of least resistance, sell the most liquid, often most attractive assets and hold onto the weaker assets. This means that the remaining investors could get stuck with a weaker portfolio, precisely what you would like to avoid: to buy high and sell low.
We are of the opinion that when an investment manager has a strong vision about trends and themes to play out in the real estate market, this manager should be able to be in front of the queue trying to sell future possibly troubled assets. A manager with a strong view will be able to capture better pricing for assets when selling and buying. In our investment approach we capture this in our management score which is the most important factor in determining the warranted discount/premium of a company or fund.
A knock-on effect of a suspension of trading in open-ended property funds is that retail investors may panic and begin selling more than they wanted/needed to, which can quickly turn into what is often referred to as “herding behavior” in behavioral finance, where groups of investors follow each other. This behavior may exacerbate unnecessary volatility and add a systemic risk to well-functioning capital markets. This can be troublesome for the market in general, but it can also create opportunities for sharpshooters.
The benefit of listed real estate is that for as long as the stock market remains open the trading will occur even during periods of distress, albeit likely at a lower price. This acts as a better forecaster of the underlying value of the portfolio/stock. Even if herding behaviors affect listed real estate stocks, in a reasonably efficient market there will be investors with sufficient analytical capability (like Kempen) that will begin buying at certain low points, thus correcting the share price to a more appropriate level to reflect the value of the REIT and its future growth prospects. Naturally, being active investors we love the market noise and volatility as it creates mis-pricings we can identify and exploit, on top of selecting long term winning REITs with strong future prospects. From the recent equity market reaction, we may conclude that REITs “lead” direct property valuations and price in the prospects of the underlying real estate significantly quicker and more accurately than open-ended property funds, or direct property valuers.
Kempen’s property investment solutions create sustainable returns for an uncertain future. The Kempen Global Property Fund has outperformed its benchmark by c.3% since inception with the UK holdings returning c.17% pa compared to c.6% pa for the UK benchmark holdings over the same period4. Our Property Strategies are designed to offer daily liquidity which we monitor on an ongoing basis. Investing in our Property Strategies means that on top of getting access to a proven and successful proprietary investment process and experienced management team, liquidity is proactively managed.
1. PERE/PEI, November, 2019
2. Financial Times, December, 2019
3. UK Office for National Statistics, December, 2019
4. Gross returns of Kempen (Lux) Global Property Fund I compared to FTSE EPRA Nareit Developed benchmark and UK gross returns compared to FTSE EPRA Nareit Developed UK benchmark from 01/01/2015 to 12/31/2019. The value of your investment may fluctuate. Past performance is not a reliable indicator of future results. There are costs involved: for further information please see the Key Investor Information Documents.
The Kempen (Lux) Global Property Fund (the“Sub-fund”) is a sub-fund of Kempen Alternative Investment Fund SICAV (the “Fund”), registered in Luxembourg. The Fund is licensed in Luxembourg and is monitored by the Commission de Surveillance du Secteur Financier. Kempen Capital Management N.V. (KCM) is the manager of the Fund. KCM is a licensed manager and is monitored by the Authority for the Financial Markets. The Sub-fund is registered with the Authority for the Financial Markets under the Fund’s license. This information constitutes an insufficient basis for an investment decision. You should therefore read the Key Investor Information and the prospectus. These documents, as well as the articles of association, the annual report and the semi-annual report, can be obtained free of charge from the Fund’s offices at 6C. route de Trèves, L-2633 Senningerberg, Luxembourg, and from the website of KCM (https://www.kempen.com/nl/asset-management). The Sub-fund is registered for offering in a limited number of countries. The countries where the Sub-fund is registered are listed on the website. The value of your investments can fluctuate. Results achieved in the past do not constitute a guarantee for the future.