Wave of maturities breaks as values are falling and returns turn negative, reports Jane Roberts
The number of European unlisted funds with imminent termination dates, or which face other challenges that could lead to closure such as investor redemption requests or gearing problems, has never been higher.
INREV’s data (as at May 2013) shows there are 96 funds with a gross asset value of €36bn that need to be wound up, or extended or restructured, in the three years between 2012-2014. The organisation’s most recent fund termination study, carried out last summer, said there were 176 funds that had a GAV of almost €70bn due to terminate between 2012 and 2016, representing almost a third of the total European non-listed funds universe. The figures include both a historically high number of funds reaching their original termination dates, because of the relatively large cohort launched in 2005-2007, and funds that have extended their lifetime at least once.
“This is a real issue and INREV’s study gets its arms around the magnitude. Whether to extend or liquidate is a very big theme” says Peter Hobbs, senior director, group business development, at IPD.
The wave of maturities breaks at a difficult time, when values have fallen in many continental European markets, particularly in southern Europe, and are down everywhere for secondary property. Add in the fact that some investors are turning away from unlisted funds – particularly closed-end funds with little liquidity – which is opening rifts with co-investors who may want to stay in, and it paints a stressful picture.
Dutch investor APG, one of the largest asset managers in Europe, has been open about its preference for making future, indirect, unlisted property investments via clubs and joint ventures rather than co-mingled funds. Managing director for global real estate, Patrick Kanters (who is also chairman of INREV), repeated that this was APG’s strategy only last month at INREV’s annual conference. The Dutch investor has been putting this into practice in investment decisions, such as its allocations to Grainger in UK residential (see more) and Pramerica in junior debt (see more).
Residential assets in play
APG is also coming out of some funds. Its intention to redeem its cornerstone investment in the semi-open geared Archstone German Fund is believed to have put the residential assets into play – against the wishes of at least some of the other investors. General partner Archstone, now owned by two US REITs, has hired Morgan Stanley to look at options for a sale or restructuring of the fund, sources say (see News)
INREV’s study found roughly one third of funds which are at or approaching termination intended to liquidate, and two-thirds intended to continue by either extending or migrating to another model. Considering whether to liquidate and sell depends mostly on “current market circumstances” and “termination options in fund documentation” according to the 54 funds which responded to this research, although to “current market circumstances” could probably be added “quality of assets”.
“In funds where you have assets that are saleable, investors will vote to sell and do other things with the money,” says Jos Short, chairman of fund manager Internos. “But those with a lot of tertiary or secondary property will continue to extend because they can’t sell at a price reflecting the underlying vehicle’s value”. This suggests the INREV study’s finding may understate the preferences of investors for liquidation, were property markets stronger.
Difficult to sell
Funds in southern Europe, for example, would find it very difficult to sell. INREV’s database has 10 funds due to terminate in the region between 2012-2014, seven of them next year and some of them very large. “There is not a great deal of liquidity in property markets anywhere south of the olive belt and not a huge amount elsewhere – liquidity is concentrated in the UK and Germany,” says Paul Robinson, a director at CBRE Real Estate Finance, which set up the PropertyMatch secondary trading platform for unlisted funds. “That is one reason there are problems; to decide whether to extend or realise, you have to ask what your realisation receipts might be and what the prospects are for selling.”
“There is not a great deal of liquidity in property markets anywhere south of the olive belt and not a huge amount elsewhere – liquidity is concentrated in the UK and Germany” Paul Robinson, CBRE Real Estate Finance
Investors in Commerzbank’s CG Malls Europe fund voted over a year ago to wind up the fund to which Eurohypo was the main lender, but haven’t sold its three shopping centre assets in Portugal and Spain, presumably because the investors haven’t had offers they wanted to accept. Last year, Unibail denied that it had agreed to buy the two Portuguese assets.
Where funds have breached debt covenants, banks rather than investors may be calling the shots. Investors in the geared Rockspring Portuguese Property Partnership (RP3) say they have written down their units to zero because the assets are completely underwater. The fund was launched in 2006, when no one predicted the problems that have since faced the eurozone.
“It’s an easy remark to say it’s all in southern Europe and that does seem to be where a lot of the problems are,” says Graeme Rutter, head of property multi-manager at Schroders. “But there are also funds with northern exposure that took too much development risk and have poorer assets.” Any fund launched in 2005-2007 with weaker assets that were geared is likely to have performed poorly.
Robinson points out that relatively more of the funds launched in the run up to the peak of the market in continental Europe had a value add rather than a core strategy and were geared. “In addition, on the continent, open-ended funds were also often leveraged, which generally you don’t see in the UK where leveraged vehicles are closed,” he says.
INREV’s study bears this out: some 54% of the funds due to terminate between 2012 and 2014 are value-added in style, with 22% core, and 24% opportunity funds. Value-added funds performed worse than core funds, returning -4.7% in 2012 compared with 0.3% for core vehicles. Opportunity funds launched at the peak were the most heavily geared, but gearing was also not uncommon for funds styling themselves core or core-plus, like RP3.
Multi managers are the investors with the best overview of the unlisted fund market. It would be surprising if they didn’t all have “at risk” investments, and some of them will have taken big write-downs, perhaps where a bank has requested a valuation and it has come in lower than the value of the fund. However, Jeremy Plummer, head of global multi manager at CBRE Global Investors, says the proportion of severely troubled funds is “quite small. Funds are clearly polarised between those with ongoing problems and others which have recovered and stabilised, though they might still have end-of-life issues”.
In extreme cases, says one source, “where the prospect of a termination crystallises a loss, investors may question whether a manager has performed in accordance with good practice. There are several cases where net asset values have been announced which were unrealistic. Has the manager been reporting NAV in accordance with market practice, or is it an artificially high NAV? The situation has exposed valuation practice, although part of the challenge is trying to assess what good practice is.”
In situations where terminating funds have performed poorly but there is equity value left fund managers may suggest that current market conditions point to extending funds and that this is in the best interests of investors. This may be the case, but the INREV report also received feedback from investors who said extension strategies are based on the assumption of an improving market, and this approach carries risks as well. The report also commented: “With the difficulties of fund-raising, fund managers have incentives to continue funds instead of terminating, but investors want the internal rates of return maximised and selling opportunities capitalised on”.
Aviva Investors currently has five UK and European funds with imminent terminations. Two, the Beach Student Accommodation Fund and the APIA Regional Offices Fund, are being wound up. In the first case, says Aviva client relationship manager James Morrow, it is because Beach’s 93% investor, the Aviva life fund, “is reducing exposure to UK property and the investment didn’t fit the ongoing strategy”. The APIA fund is due to terminate next year and had high gearing which coincided with falls in the value of its UK regional assets. Aviva expects to complete the final sales soon.
For the other three, the manager has proposed extensions and investors are due to vote shortly. Aviva has recommended an extension out to 2019 for the Quercus Healthcare Fund, and two-year extensions for Ashtenne Industrial Fund and Aviva Central European Property Fund. Morrow says this is to allow time for orderly sales of the assets. The proposed extension for Quercus is longer because of the specialised nature of the property, he says. “We don’t want to flood the market.”
Shorter-term extensions can be less complex than longer-term restructurings, though they might involve managers agreeing to a reduction in fees and where assets were geared, refinancing. Any event which is more akin to a new investment is certain “to be used by investors as a means to restructure a fund and bring it up to date with new funds being launched today”, Robinson observes. “Everything will be on the table, control, oversight, leverage, fees…”
For those investors who still want to exit, the secondary market may be the only option. A couple of years ago, received wisdom was that investors in continental European funds were not interested in liquidity. Certainly pre-crisis fund documentation was often restrictive with barriers such as pre-emption rights and manager consent required to trade out. It is a sensitive issue, as the market is putting a deep discount on the unlisted fund sector and trades demonstrate net realisable value rather than net asset value.
Melville Rodrigues, partner at CMS Cameron McKenna, comments: “As part of restructuring and extending closed-ended funds, investors often look for greater protections including ensuring their units will be transferable. In the context of being entitled to transfer units, investors are tending to resist managers’ absolute consents (as a pre-condition to an investor transferring units) and pre-emption rights in favour of other investors.”
In January this year, US secondaries buyer Landmark Partners estimated that global unlisted real estate secondary trading volumes in 2012 were $12bn and could be $14bn in 2013 – although the firm does not break this out by region. There are at least two secondary portfolio transactions underway (see News).
The difficulties of exiting may be one more reason why many investors are now more focused on joint ventures and club deals rather than funds. Hobbs says: “Investors are looking through these funds into underlying drivers of performance and risks. Before the crisis, their investments tended to be spread across managers and funds. The crisis has helped them decide on which managers they want to form long-term relationships with. Bigger investors are reducing to a smaller number of funds and managers, and are focusing on counterparty risk.
“Clients want to know what the risks are in their portfolios, like tenant and credit risk as well as how much leverage they should take on. I think this increased focus on risk management is one of the enduring benefits of the crisis.”