Aerial view of Frankfurt, Germany
Fund withdrawals from German open-ended funds are warning of a deepening crisis in an asset class that was once a mainstay for both large and small-scale investors.
German investors withdrew about €279m from open-ended mutual property funds in November last year, marking the fourth consecutive month of net outflows and nearly doubling the amount withdrawn in October.
Figures from the Düsseldorf-based Barkow Consulting show the downward trend of investors withdrawing money from the open-ended funds to be accelerating. Barkow says in its latest note that it expects further acceleration, "due to the persistently difficult conditions in the property sector". Barkow bases his analysis on figures provided by the Bundesbank.
Fund leakage at both sales and redemption level
The leakage from the funds is happening at two levels - sales of fund units through the funds' distribution channel, and fund redemptions (available to the investor with a 12-month notice period). Gross sales of fund units in November were €242m, about the same as in September, but well down on typical fund sales in previous years of between €500m and €1bn.
However, redemptions exceeded more than €500m for the first time since August 2017, at €518m. For years, the typical monthly redemption rate was between €100m and €200m.
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.
Germany's public open-ended funds still manage more than €130bn, so the leakage in fund outflows is still manageable, considering many of them have a substantial liquidity cushion.
Interest rates and inflation
But the wider real estate sector is still suffering severely. With rising interest rates, construction activity in the residential, office and commercial property sectors has plunged. The number of permits issued for residential construction between January and October fell by 26.7% year-on-year, to a total of 218,000.
The purchasing power of households has declined, while inflation has also driven up labour and material costs for contractors, and made construction projects significantly more expensive for the end-buyer. These have either withdrawn from the market, or are adopting a 'wait-and-see' attitude, meaning there is also less product offers on the market for the funds to buy. All of this has darkened sentiment towards real estate in general.
Barkow says the absolute amount of money making up the gap between inflows and outflows is now 'significant'. While banks are engaging in ever-more competition to woo investors with attractive fixed-term deposit rates, with 12-month rates of 4% now available, the traditional yield level of 2-3% on open-ended funds would look less appealing. However, the last two months have seen these 4%+ offers on deposits become scarcer, at least for now.
Scope says all asset classes affected
The Berlin-based rating agency Scope confirms that the downturn in fund activity affects all property asset classes, nearly all of whom have seen price falls compared to mid-2022. Residential could fall by 15% from its highs, while there's no sign yet of the office market bottoming out, nor any clear price visibility.
The profile of prospective property buyers has also been shifting over the past two years, with few large investors now financing their investments with borrowed capital. Those with deep pockets and solid financing are very much in a favoured position to snap up potential bargains.
Scope and other observers have not ruled out temporary fund closures, as witnessed back in 2012, when the funds were forced to protect their liquidity agains a background of hefty redemptions. We still have a way to go until the funds follow the example of KanAm's Leading Cities Invest fund in writing down the value of their property portfolio, but there will certainly be more write-downs.
INTREAL sees institutional outperforming public funds
Meanwhile, German fund advisor INTREAL says the open-ended funds are entering a consolidation phase, likewise utilising the figures from the Bundesbank for public mutual funds and institutional funds.
A comparison of the two categories shows that institutional funds outperformed public ones. The total net fund assets of all open-ended institutional real estate funds (public and institutional) equalled €173bn by the end of 2022. Nine months later, that figure was €177.9 bn, an increase of €4.5 bn.
A look at the net cash inflows shows that these amounted to €6.5 bn during the first nine months of 2023. Inflows during the same period last year still came to €11.1 bn as inflows decreased by around 40%.
Michael Schneider, CEO at INTREAL, commented, "The number of new funds has gone down, but that is not the same as saying there are no new funds at all. Funds continue to be initiated and subscribed for the use classes residential, logistics and food retailing."
"In addition, some of the funds already launched still have open capital commitments. These are drawn down and invested in emerging opportunities. Cases in point include selected office and government buildings, among others."
On the leakage from the funds, Schneider said: 'Cash inflows for public funds dried up much faster year over year than was the case with institutional funds. That being said, the bottom line still shows modest growth. There is a chance that 2024 will see higher repayment levels in line with contractual notice periods of 24 or 12 months, as the case may be.’
Consolidation
In regard to the overall situation, Schneider said: ‘The market is entering a consolidation phase. We will not be seeing the high cash inflows and growth rates of recent years again any time soon. Given the currently available alternative investment options in the fixed income sector, the market will temporarily flatline on a lower level.’
‘However, what makes me optimistic for both fund categories are the following aspects: If long-term interest rates were to stabilise on their current level or indeed were to fall, real estate fund investments would remain a highly attractive investment class within the scope of risk-diversified portfolio allocations, particularly so if predictable regular payouts are of material significance.’
‘This explains why our institutional funds receive barely any redemption requests from institutional investors. Whenever the odd request does come in, we sit down for talks and usually manage to convince those investors who have long-term horizons that now is not the best of times to start selling real estate, which is what such a payout tends to necessitate.’
What should investors do?
Schneider has the following advice for the professional investors in funds. ‘With that in mind, investors will generally change their minds and decide to keep their stakes in a given fund. On top of that, many professional investors are closely watching the real estate market lest they miss the right moment for fresh investment opportunities. By contrast, what makes me confident when it comes to public funds – aside from the effective contractual notice periods – are, on the one hand, the high liquidity and occupancy rates and, on the other hand, the low leverage ratios.’
‘Even when faced with temporarily increased cash outflows, fund managers are thus left with plenty of possibilities for action in order to cushion these before it become necessary to sell off real estate at inopportune times or to actually wind down a given fund.’
REFIRE: It remains to be seen whether the fund withdrawals will continue at the current pace, which would undoubtedly put many funds under pressure. It's unlikely German investors will suddenly take to the stock market en masse to get their indirect real estate fix. We're tracking the fund figures closely.
