EURO ZONE: Open-ended nightmare

You have to be prepared for shocks in the private equity real estate industry these days, from fair value asset write-downs to an LP saying he can't meet a cash call.

One thing you could rely on, though, was being able to find an exit with a German open-ended property fund. But even that certainty has now disappeared.

Robin Marriott

At the start of the year, the story was completely different. As PERE reported in February, open-ended property vehicles in Germany were enjoying a renaissance after fraud-related scandal left the industry sinking in quicksand in 2005 and 2006. The comeback story seemed complete by November last year, when net inflows once again began flowing. It seemed like a fairy tale ending.

However, events in more recent months suggest this story might not have a happy ending after all.

Perhaps spooked by official data that Germany is in recession, investors have been withdrawing funds from the €84 billion industry at an alarming rate. This has led to funds temporarily suspending redemptions.

This state of affairs has come about because German law requires funds to hold a minimum of five percent of assets in cash or liquid assets to guarantee the redemptions of outstanding shares at all times. If the liquidity reserve threatens to fall under the minimum floor, the redemptions of shares may be suspended.

Until now, this has only happened three times. In December 2005, Deutsche Bank Real Estate's Grundbesitz-Invest suspended redemptions for three months while it revalued its property portfolio. Then, in January 2006, KanAm suspended redemptions at two of its funds following a negative ratings evaluation.

KanAm is now doing it again, but it is not alone.

The Frankfurt-based branch of Morgan Stanley's real estate management business has also experienced “major, unanticipated withdrawals”, prompting it to suspend redemptions. There could be more still.

But redemptions at German open-ended funds are not good news for private equity real estate. For one they close off a potential exit avenue, not least because – up until recently – German open-ended funds were one of the few groups around with equity.

The most graphic illustration of this effect was seen in October. A deal agreed by Tishman Speyer and UBS Real Estate Finance to sell the German Opernturm Tower was cancelled by KanAM. The deal asset sale price was reportedly in the region of €400 million to €600 million.

At the time, a spokesman told Reuters the collapse was the result of KanAm's reluctance to increase its rental exposure to the German financial industry. That argument might be reason enough to pull out, but then KanAm revealed it had to halt redemptions at one of its open-ended funds due to liquidity concerns, not an unusual scenario in these times.

There is also a second reason to recoil from the woes of the German open-ended funds: a suspension of redemptions is not translating into fire sales.

In a recent study of past redemption suspensions, the German mutual fund association, the Bundesverband Investment und Asset Management (BVI), concluded that there were no resultant fire sales. Instead, the suspensions turned out to be “a useful tool to protect investors from liquidity risk”.

Although private equity real estate might not see any fire sales from the suspensions, the issue has highlighted the fragility of the open-ended model vis-à-vis the relative stability of the closed-ended model. For all the criticisms LPs might have about the closed-ended vehicle, it does at least make all sides look to the long-term.