The events that followed the EU referendum in June 2016 may once again prove to be relevant to the way investors respond to a deal or no-deal Brexit in March this year. The referendum sparked a wave of selling from investors that were all looking to exit UK property in a hurry, which put pressure on fund managers that were unable to sell properties quickly enough to generate the cash that they needed to return funds to investors. This resulted in six open-ended property funds suspending trading, while others imposed penalties of 10% to 15% to discourage investors from withdrawing their money, or “panic selling”.
This panic exposed the fundamental problem with open-ended direct property funds: namely they invest in something inherently illiquid – physical bricks and mortar – and thereby any liquidity offered can be unreliable.
Real estate investment trusts (REITs) on the other hand provide underlying liquidity during times of panic selling as they are listed on the stock market. While this obviously doesn’t protect the share price from falling, it does mean that the investor will always be able to get his money back within minutes, albeit at a lower price if there is panic selling.
Perhaps in anticipation of an “ugly Brexit”, the Financial Conduct Authority (FCA) proposed tougher rules for open-ended property funds in October 2018. Under the regulator's plans, fund groups would be required to suspend dealing in their property funds as soon as there is 'material uncertainty', as expressed by an independent valuer, of more than 20% of fund assets.
The FCA argued this would 'reduce the risk that some investors may lose out because the units in a fund are wrongly priced'. Under the FCA's plans, responses to these periods of market stress are likely to become more uniform, with suspensions, rather than exit levies, becoming the norm.
If the FCA does change how open-ended funds operate, it is widely expected to increase demand for REITs due to their better liquidity. However, when the share price of a REIT slumps in value due to panic selling, it often creates a buying opportunity for brave investors willing to look beyond the short-term.