Capital is targeting the €24bn of property in frozen and liquidating German open-ended funds, but the shrinking sector is struggling to dispose of assets at book value, reports Lauren Parr
Forget the banks and their secondary real estate portfolios, German open-ended funds should be a fantastic source of product for capital targeting prime European property.
Seven open-ended funds are in liquidation, while a further seven are closed and need to sell property to generate enough liquidity to re-open and meet redemptions (see table below). But these 14 funds face a catch-22 problem: how to sell assets at book value.
“Many open-ended funds have stock that cannot be sold at present valuations,” says Martin Braun, partner and head of capital markets in Germany at Cushman & Wakefield. The funds cannot cut their losses because German law dictates that they cannot sell assets at more than 3% below the latest valuation, which takes place annually.
“We are aware of a lot of properties and even portfolios worth several hundred million being in the market for weeks or months and not selling,” says one London-based German investor. While valuers are thought to be starting to cut their valuations, in many cases there is still a mismatch between book value and market value.
For example, SEB’s ImmoInvest, which is frozen and hopes to re-open this year, instructed Merrill Lynch to market a 50-90% stake in its major Berlin asset, Potsdamer Platz, but none of the investors that were approached came close to the asking price.
Pramerica’s City challenge
Pramerica faces a similar challenge in trying to sell 85 Fleet Street in the City, held by its TMW Weltfonds, even though the former Reuters building is fully let with more than 10 years left on the lease. It has been on the market since September but has yet to attract an offer close to its appraised value.
It is debatable whether the London market has softened since September or if the asset’s appraised value is too high, but a combina-tion of both is likely to have affected the building’s sale prospects, along with the fact that a raft of London offices hit the market towards the end of last year.
AXA Real Estate decided to liquidate its frozen €2.5bn Immoselect fund in October after a strategy prepared last spring to sell 33 properties in seven countries failed.
It is down to fund managers to select the right product for sale, with core property being in highest demand.
Lars Breuer, managing director and head of investment at Savills Germany, says that while a lot of open-ended funds’ stock is of prime quality, the toughest assets to shift “don’t fit into the categories that work now; they are not opportunistic or development assets, as they have an average of five, six or seven years left on their leases, yet are not core assets, because the lease is too short.”
An opportunity for investors
German open-ended funds have flipped from being acquisitive buyers – in 2008, CBRE estimated they had €22bn to spend to net property sellers, a trend that looks set to continue for the forseeable future, because more funds are being dissolved.
This creates an opportunity for investors to buy assets from them over the three-year liquidation period. Assets not sold in this period will be turned over to the depository bank, which will have to liquidate them.
Aberdeen Asset Management’s Degi fund is among those selling its 32-asset portfolio as part of a liquidation process by 2014. By October, it was already engaged in talks to sell seven properties for €700m.
Open-ended funds can be grouped into three categories: those under pressure to sell; those closed, but looking to re-open; and those in pretty good shape with net inflows, which may be profit-taking in some markets as well as investing in others.
In terms of capital flows, May could be a turning point for the market, when SEB Immoinvest and CS Euroreal, each with about €6bn of assets, must decide whether to reopen or liquidate. KanAm Grundinvest and AXA Immosolutions are in the same boat.
The rules governing open-ended funds limit the amount of capital they can hold, so they must buy property if they receive huge inflows. On the other hand, if they do not have enough cash to meet redemptions, the management can close the fund for up to two years, during which time they must generate the capital to pay back investors.
If they can’t do so, the fund has to be liquidated and they become forced sellers. Will this be another factor pushing values down in the markets they are invested in?
Morgan Stanley hints that it will, particularly in office markets. In a report last October, called German Open-Ended Funds: The Great Unwind, its analysts pointed out that offices make up 72% of German open- ended funds’ portfolios, mostly in Germany, Belgium, the Netherlands and Italy.
The market “most affected by funds’ liquidations will be Dutch Offices”, the report said, with liquidating or closed funds owning the equivalent of 4.6 times the average Dutch office quarterly trading volumes.
But Sebastian Lohmer, portfolio manager of TMW Pramerica Property Investment, says: “[SEB and Credit Suisse] are globally invested funds, so even the sale of €12bn of property in the next three years will not have an impact on the market. Based on their market share, the funds would all have to liquidate at the same time to have a big effect on a single market, as their assets are too widely spread by region, city and asset class.”
While funds’ disposals may not destabilise the wider market, they could create a glut of secondary property. “It will exaggerate the polarisation problems we already have, but it’s not going to sink the market,” adds the London-based investor. “These guys do a very good job of managing their liquidity so I don’t think they will crowd the market.”
The capital seeking to buy these portfolios comes from Asia, the Middle East, North America and Russia, as well as from other European countries. KanAm is selling three London offices valued at about £750m from its suspended Grundinvest fund to Malaysian investor Permodalan Nasional Berhad.
Most buyers are equity-driven or low- leveraged investors such as large pension funds, insurance companies and sovereign wealth funds. Family offices and private investors are in the market for smaller lots.
Where they are buying, German funds are investing heavily in Germany. “There needs to be a reason and a story to go into other markets,” says Savills’ Breuer, but he highlights a run into Scandinavia owing to its economic profile and a favourable exchange rate. “The lot sizes of single deals also need to be lower than before,” he adds.
One of the few remaining large, healthy funds, Union Investment Real Estate, hopes to invest around €1.5bn, mostly in Europe, this year, with a focus on the main cities in the UK, Germany, France, Netherlands, Belgium, Scandinavia, Poland and Czech Republic. It will also sell €500m-€1bn of assets, depending on market possibilities. In 2011, it invested €1.3bn and sold several hundred million of property.
German open-ended funds were designed for German retail investors that want to invest up to €10,000 in a stable, low-risk investment product. But the sector became destabilised partly because institutions also piled in and used them as a “cash-plus” product, because of their daily liquidity.
Many in the German market believe open- ended funds are entering their end game. Future capital flows are difficult to predict, but one German property agent believes only four funds will survive in the mid term. “The original idea of a product for long-term retail investors is still the base for the four healthy funds,” notes Braun.
Lohmer says none of the closed funds have succeeded in re-opening, so some people expect all the so-called independent open-ended fund managers will disappear. “You will be left with four bank-related funds: RREEF, Commerzbank, Deka and Union.” RREEF, of course, is for sale, as part of parent Deutsche Bank’s sale of its asset management business.
While these funds distribute units via their parent banks’ branches, others, such as SEB, lack a large distribution platform. So “SEB attracted professional investors which, of course, did not fit the idea of open-ended funds,” Lohmer adds.
New structures offer exit route
The sector hopes to transfer portfolios of distressed funds, or dissolved funds, into alternative fund structures. This would allow the new structures to buy packages of property at a discount, but a lot of the assets would not then come onto the wider market.
Open-ended funds are most likely to morph into spezialfonds, which cater for institutional investors (see panel, left). “It’s not the most transparent process, with conflicts of interest for old and new inves-tors,” says Lohmer. German regulator BaFin will also have to approve new structures.
KanAm aims to transform its KanAm Spezial Grundinvest fund into a spezial-fond following initial talks with its 80 institutional investors. The vehicle recently banned redemptions for three months after one investor sought to return all its shares, exceeding the fund’s liquidity.
Says Braun: “Of course the objective of all fund managers is to keep as many of the assets under management as possible, so they could try to converge their open-ended funds into one special fund.”
Redemption for investors may be damnation for sector
German open-ended funds were thought to have recovered from a low point in 2005/ 2006 following a bribery investigation and fears of over-valuation.
But the industry suffered big redemptions after the credit crunch. Investors’ ability to buy in or sell out at any time means that managers “cannot control the funding” says Cushman & Wakefield’s Martin Braun.
“When the equity markets went down, institutional investors used the funds to park liquidity. Their investment decisions had a direct impact on funds, which is why some ran into liquidity problems and had to close.”
Since then, inflows “are at best halting”, said DTZ in a report in September. According to the German Association of Investment Funds, or BVI, net inflows of German open-ended funds (excluding special funds) totalled €1.2bn from January to December 2011 – about half the volume in the previous year. Meanwhile, spezialfonds, designed for institutional investors, recorded net inflows of €2.29bn.
Investors in currently closed open-ended funds have been redeeming at discounts on the secondary market, according to Morgan Stanley (see graph).
The funds were also hit by uncertainty brought about by draft legislation on investor protection in May 2010, after a few had temporarily re-opened. Rules introducing a 24-month minimum holding period for new units and a 12-month redemption period for all existing units don’t come in until next January – and that may be too late for funds with deadlines to re-open this year.
Institutions will want to redeem ahead of the longer notice periods coming into force; Allianz plans to liquidate its open-ended fund of funds, which manages €1.2bn of assets. Insurers will no longer be able to invest, as they can only invest in products with a maximum six-month notice period.