Are open-end core funds a viable investment proposition for the private real estate sector?

That familiar question is back on the radar of institutional investors as they grapple with the economic stasis enforced by covid-19.

PERE reported last week about AEW’s decision to establish a gate on the AEW Core Property Trust, a $9.5 billion GAV US-focused vehicle, halting withdrawals as well as incoming capital. AEW is not alone. At least seven UK property funds suspended trading as early as mid-March amid the deepening market volatility caused by coronavirus.

This is not the first time managers have established gates en-masse. A wave of fund suspensions followed the 2016 Brexit vote to curb surging redemptions, and similar activity repeated in December 2019. The global financial crisis in 2008 also triggered a freeze on unlisted funds redemptions across Europe – particularly in Germany – the US and Australia.

Most real estate consultants PERE has spoken with since the pandemic began say a lot of their time nowadays is spent tracking the open-end core funds universe. There is consensual fear among them that, if push comes to shove, there will be more gating, and investor clients will be caught in what they thought was a liquid product. More panic triggering more redemptions, in turn triggering more suspensions.

The debate around the viability of the open-end fund model, which reignites every time there is a crisis-fueled run on redemptions, has always been based on the quandary: is this a structure that allows for daily, or even quarterly withdrawals, compatible with an illiquid asset class like real estate?

This crisis has, however, added new complexities to the debate, particularly relating to the global lockdowns in place. Before, managers had the option of initiating fundraising roadshows, or asset sales, to fund distributions. Not this time. With most executives prohibited from leaving their homes and most  investors facing liquidity issues in their own portfolios, new capital raising efforts are highly unlikely.

Meanwhile, beyond the practical impossibility of organizing market auctions for assets, uncertainty over valuations is an added worry. Managers and valuers alike are struggling to determine whether to hold the first quarter NAV of their portfolios flat or to write down. And with no transactions closing in recent weeks, firms have little visibility into how the market is pricing in this disruption.

Then there are those open-end core funds with a significant exposure to retail or hospitality – the two most severely impacted property sectors right now.  They will surely take even higher valuation hits, which could impair their overall performances. In Australia, for instance, major unlisted shopping mall funds generated record low returns in March, according to the MSCI/Mercer Australia Core Wholesale Monthly Property Index. A private malls fund managed by Lendlease reportedly yielded negative 13 percent over the past year.

How open-end core funds emerge from this crisis will determine their suitability as a REIT substitute or alternative for some investors. Their defenders herald how they come without the higher volatility of a listed product. Those defending open-end funds also believe investors seeking long-term investments do not time the market. For such investors, investing in income-generating assets via private funds will remain an attractive proposition.  But that evergreen argument will do little to stop the naysayers casting doubt on the model in times of crisis.

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