An alternative solution for illiquid real estate funds

Real Estate Investment Trusts (REITs) may be a viable alternative to open-ended funds holding illiquid real estate for those operators and investors who are concerned, respectively, about runs on assets and dealing suspensions. For operators, REITs have the advantage of being closed-ended, meaning that they do not suffer from redemption requests and therefore underlying assets are not affected by investors’ desire to withdraw capital. Meanwhile, investors can achieve daily liquidity without the risk of gates being imposed, as REITs are publicly traded vehicles with publicly available, transparent pricing. Investors also benefit from regular distributions, as REITs must distribute at least 90 per cent. of the income profits of their UK property rental business. Further information on REITs can be found in the Macfarlanes Guide to UK REITs.

Operators of open-ended funds holding real estate are often faced with difficulties when investors try to withdraw their capital at short notice, as the illiquid nature of the assets makes it difficult to meet those redemption requests. Operators of such funds are often faced with a choice between selling the fund’s best assets at reduced prices or imposing unpopular suspensions of dealing. The FCA, in consultation paper CP 18/27: Consultation on illiquid assets and open-ended funds and feedback to Discussion Paper 17/1, noted that this issue was particularly acute following the result of the UK referendum on EU membership in June 2016.

The FCA, in its recent paper, makes two particularly notable proposals:

• funds holding immovables be required to suspend dealing when there is material uncertainty about at least 20 per cent of the value of scheme property; and
• funds be required to suspend dealing when at least 20 per cent of the value of the scheme property is invested into other funds which have suspended due to material uncertainty.

Although, in many ways, these proposals are a welcome development and are likely to prevent a run on assets, they highlight challenges faced by open-ended funds and may lead to more lock-ups and the imposition of gates.