Historic outflows at Germany's open-ended property funds
REFIRE has been reporting since the middle of last year on how Germany's open-ended property funds are experiencing significant net outflows, a trend not seen in over 17 years. According to a new, detailed report by the Berlin-based rating agency Scope, the shift in investor sentiment and subsequent capital movements could now mark a critical juncture for the sector. As of early 2024, net outflows have already reached a staggering €500 million, with the cumulative total since last year exceeding one billion euros.
Scope forecasting further outflows
Scope analysts Sonja Knorr and Hosna Houbani have extensively analyzed these trends, projecting that "significant net outflows are likely for 2024." Their report predicts that the peak of these outflows will occur in the third quarter of the year, raising concerns over the liquidity and stability of these funds. The potential for increased redemptions means fund managers might have to resort to selling properties, possibly at discounts, which could "have negative effects on the fund unit price," as per Scope’s analysis.
In February alone, net outflows, i.e. outflows minus inflows, totalled 430 million euros. "These were the highest outflows in one month for more than six years," according to researchers Barkow Consulting, which tracks fund flows carefully. It was the seventh month in a row in which, on balance, more money went out of the funds than came in. Outflows now totalled €1.201 billion. At 680 million euros, the volume of funds returned ("reflows") in January had already been the highest since August 2017.
The German preference for property funds
Open-ended funds have traditionally been the preferred method for German investors (retail and institutional) to gain exposure to the property sector without contending with the volatility more typical of the stock exchange, which is often viewed with distrust. When interest rates were at or below zero, the funds generated solid returns with a high degree of safety. Once interest rates jumped two years ago, this all changed.
There are two factors that are causing problems for property funds in connection with the turnaround in interest rates. Firstly, other investments, from fixed-term deposits to government bonds, are paying more interest than before. Economists call this effect the "higher opportunity costs" of holding property funds. Yields with which property funds used to be able to attract investors in droves now appear rather meagre compared to other investment products. On the other hand, the funds themselves are struggling with falling house prices. The valuers, who have to assess the properties in a fund on a quarterly basis, are downgrading the fund contents.
Fund strategies and variations
In response to the anticipated outflows, fund managers have begun adjusting their strategies. The introduction of a twelve-month notice period for fund redemptions in shares purchased since 2013 has allowed more predictable liquidity planning. Funds anticipating greater net cash outflows are now positioned to "generate additional liquidity through property sales," an adjustment aimed at mitigating immediate liquidity crises without destabilizing the funds' long-term positions.
Also, the liquidity situation varies significantly across different funds. For example, among the 13 largest funds with assets over 1 billion euros, liquidity ratios range from 29.3% at Deka Immobilien Metropolen to just 10.5% at Uni Immo Wohnen ZBI. This disparity highlights the diverse strategies and conditions within the sector. Notably, six of these funds saw their liquidity ratios decrease over the past year, with "Uni Immo Deutschland" experiencing one of the sharper declines, a decrease of 2.4 percentage points, though its liquidity ratio remains above average at 16.4%.
Regulatory changes and investor confidence
In light of these challenges, recent regulatory changes aim to stabilize the market and prevent the kind of mass outflows that led to significant crises in the past. New legal provisions have established barriers to prevent excessive fund outflows, introducing mandatory holding periods and extended notice periods for redemptions. These changes are designed to curb the rapid sale of fund shares and restore investor confidence in these products.
At the same time, the secondary market for trading in property funds is flourishing as investors head for the exits. Pricing in the secondary markets does appear to be bottoming out, perhaps indicative of a stabilisation for prices in the property assets themselves, as we reported in last month's issue of REFIRE (Nr. 231).
At 64.8%, the share of real estate funds made up the lion's share of trading turnover on the secondary market of Fondsbörse Deutschland Beteiligungsmakler AG in the first quarter of 2024. The overall volume of trade on the platform (for all tradeable asset categories, such as private equity or renewable energies) rose in Q1 to €71.75m, from €47.48m in the same period of 2023.
Still, as German open-ended property funds navigate this turbulent period, the combined effects of regulatory changes, market adjustments, and strategic fund management will play pivotal roles in shaping their future. While the outflows present immediate challenges, the responses by fund managers and the broader regulatory environment will determine the resilience and adaptability of these investment vehicles in the face of evolving market conditions.