Following on with the same theme, we have noticed a sharp increase recently in the number of distribution companies and marketing teams selling commercial property funds in various guises.
The marketing literature hints heavily at stellar ongoing returns, limited or zero downside risk, and no correlation with the ups and downs of the world’s business and economic cycles.
Some of these vehicles could be worth considering if the underlying asset is generating its income from a sector where the supply and demand curve is likely to remain positive.
In relatively low amounts and percentages (repeat that three times), these vehicles can perhaps provide useful diversification to a portfolio of traditional assets.
But the oft-invoked saying that ‘If it looks too good to be true then it probably is’ should always be borne in mind, and one should tread with caution.
We don’t have to go very far back in time to see how things can go very wrong indeed for a property fund and the investors in it when commercial values fall.
Countless commercial property funds went into ‘lock up’ or liquidation following the 2008 collapse of Lehman Brothers, which in turn led to the ongoing financial crisis that is still being felt today.
Some of those funds were launched by the ‘world’s biggest banks’ and their in-house private banking arms, who then sold them directly to their database of bank account holders, including mom-and-pop retail clients and retirees.
Investors who bought funds from those banks perhaps thought that the banks were too big to fail and, even if they did fail, investors would be protected.
Wrong.
If a fund owns physical property and then uses that property to generate income from leases, lets, rents, or commercial factory production in one form or another, then the value of the underlying property goes a long way to determining the end return to investors.
This same value is calculated by a property appraisal company (whose bill for services rendered is, more often than not, paid by the fund management group itself).
The value is based in large part on the return on equity that is being generated from the building on any particular valuation date.
While a fund is generating high single-digit returns everyone is happy to remain invested – perhaps thinking it is going to last forever.
However, in order to be able to offer such returns the managers have to be pretty much fully invested all the time, which leaves little room for an exit strategy because all the cash is tied up in physical assets.
As returns start to fall, more and more people want to sell their holdings to use the proceeds elsewhere. But the managers may not have enough cash to pay the redemption requests and they can’t sell the properties quickly enough – if at all.
The fund can then go into a ‘lock up’ phase and no one gets anything until the managers can find a buyer or buyers for the property, and that can take a long time. After all, it’s falling in value, so who’s going to buy?
Sometimes the sale come too late to prevent a forced liquidation and a subsequent payout of 10 cents on the dollar with a nice letter of apology. Thanks for that.
Property valuations in the US and Middle East, for example, were hit particularly hard following the 2008 crisis and still today, some five years later, there is a vast amount of bricks and mortar that is worth a fraction of what it was.
Some of those ‘safe’ investments are now worth 20 per cent of what they were when the original investment was made. And to add insult to injury, even that 20 per cent is still frozen because buyers cannot be found.
The fact is that prices were at silly levels back then anyway, having been ramped up by the irresponsible and reckless lending practices of the very same banks that were at the same time selling the very same funds that owned those very same properties … and still are and still do.
Sublime irony, you couldn’t invent it.
Jerry Dingley and business partner Tim Whiteley have a combined 50 years’ experience advising expatriates and international investors both onshore in the UK and in the Asia Pacific region. Specialist areas include offshore trusts and wealth protection vehicles, private client portfolios, QROPS UK pension transfers and creating tax-efficient retirement solutions for individuals around the world. Contact them by email at info@qropspensioncentre.com
Important Note: This article contains general information only and is not intended to be taken as specific financial advisory, investment, or tax advice. A personal analysis should be obtained before acting or refraining from acting upon any information given.