Anthony Hilton: Could cracks in property be set to widen?

In June 2007, the near-collapse of two hedge funds backed by Bear Stearns gave the first hint of the crash to come. They were both heavily invested in mortgage-backed securities, and had problems with liquidity when clients got nervous about property valuations and wanted their money back. Unfortunately, the funds did not have the ready cash to meet the demand, and the underlying assets proved difficult to sell in a hurry.

Seeing what had happened at Bear Stearns, investors in other funds decided they wanted their money back too.

The pressure gradually spread through the system, setting in motion the trends that finally erupted in the banking crash a year later.

There were people around last week — senior people — musing nervously whether the liquidity problems that have surfaced in most of the leading retail investors’ property funds since the surprise vote on Brexit might have similar knock-on effects in the wider property sector, and through that into the financial system. Happily, there is no sign of that yet but the gloss has certainly gone.

Commercial property is an obvious casualty of any decision to leave the European Union because there will be fewer tenants around.

People may argue about how many businesses will actually leave the UK, but no one expects any more to come here. The net result, therefore, has to be fewer tenants and more vacancies — leading to lower rents and valuations.

Meanwhile, the Financial Conduct Authority (FCA) has some questions to answer. SCM Direct, the fund management group run by Alan and Gina Miller, warned the watchdog on the Monday after the referendum that large UK property funds needed to be urgently repriced or suspended to protect investors. This followed a trading session in which shares in leading property companies had already fallen sharply — British Land by 19%, Land Securities by 16%.

However, despite this warning — and equally despite the obvious distress in the property sector — the majority of funds took almost two weeks materially to reprice or suspend dealing.

This matters because, as highlighted in a blog on SCM’s website, the failure to reprice rapidly meant that those investors who successfully exited the fund in the early days got back far more than they should have, at the expense of those left behind. This is totally at odds with the responsibility of managers to treat customers fairly, and is one of the things the FCA is meant to police. Its obvious failure to insist on immediate repricing suggests strongly that it was asleep at the wheel, or perhaps asleep pending the arrival of new chief executive Andrew Bailey, who only started on July 1.

But the embarrassment does not, or should not, stop there. It is not the first time funds of this nature have got into trouble; a similar liquidity problem in New Star’s property fund led to its ultimate undoing a few years ago. Even that was hardly a surprise — or should not have been — because you can go back 40-plus years to the 1974 fringe-bank crisis to find exactly the same things happened in that property crash when firms like Property Growth Assurance had to close their doors.

The reality is that it is fundamentally unsound to offer daily liquidity in a fund where there is not daily liquidity in the underlying assets. Such funds get into trouble each time there is a sharp and sustained fall in property values. Yet no one on the regulatory side seems to draw the obvious lessons that such investments are unsuitable for retail investors, who need and value liquidity and do not appreciate or understand how they might get locked in.