I came across an interesting article recently on the Financial Times website. It is interesting for a a number of reasons which I will discuss. This is the article in question -

A comparison has been drawn between the recent halt to redemptions from open-ended property funds in Europe and the situation in Germany in late 2005/early 2006. At that time, temporary fund closures and subsequent restructuring were necessary due to portfolio valuation reviews and a general loss of investor confidence. Today, however, redemption restrictions do not stem from “self-made” issues within the commercial property industry but from the turmoil within the financial markets as a whole.

The current heightened redemption levels have not been caused by a mass withdrawal of cash by a large number of retail investors. Rather, the trouble has stemmed from a few large-scale institutional investors withdrawing big chunks of capital motivated by the liquidity problems they face internally. Their strategy of reducing exposure to commercial property is debatable since real estate investments have outperformed equity investments in most instances. With most of the affected funds frozen for periods of at least three months, it is important to consider how liquidity levels can be increased during this time. For those funds not supported by temporary liquidity injections from parent companies, there are typically three main approaches: continued retail and institutional investment, selling assets, and restructuring property finance to achieve higher leverage ratios. But how effective can these tools be during this precarious financial climate?

Funds that have been frozen may be able to generate liquidity naturally, whilst frozen, funds can still benefit from incoming cashflows generated by investors purchasing shares. Furthermore, liquidity will be secured via organic growth, generated by rental income surplus and interest earned on the remaining liquidity.

However, this is unlikely to raise a fund’s liquidity ratio to a comfortable short-term operating level.

Fund managers also have a part to play in securing liquidity. When redemptions were halted by these property funds some selling orders had not yet been exercised. These will be executed once the fund reopens, so it is essential for the fund manager to convince potential sellers to reconsider.

While fund managers may be able to stave off some existing redemptions, raising fresh capital will be difficult. Retail investors are more likely to prefer the safe haven of state-backed securities or guaranteed saving deposits. As institutional investors continue to reconsolidate their portfolios, it is likely to be difficult to raise capital in the open financial markets upon reopening.

Given the problems associated with raising fresh equity from investors, funds can either attempt to sell properties, or can align with financially strong joint venture partners who take over minority shares on an individual special purpose vehicle or fund level. But with property yields increasing by 200 basis points and a lack of operative buyers due to tighter credit conditions, this may not be a viable option. Furthermore, actual property sales below book value would only crystalise real losses.

The third alternative is to refinance the portfolio, targeting a higher loan to value ratio and therefore releasing additional liquidity. However, this may not be a sustainable approach, as finance is only available at very high margins.

So what is the way forward for the funds upon reopening?

Ill-considered redemptions are not the answer: fundamentally these are well-performing long-term investments and should be treated as such.

Frozen funds must focus on adapting to the current financial circumstances and explore alternative options for raising capital. One solution may be to consider other potential sources of finance over traditional lenders; in the recent past, sovereign wealth funds and Canadian pension funds have been increasingly interested in European real estate investments.

Another option may be a change in management structure and fees to increase the dividends, motivating investors to maintain their shares within the fund.

Another possibility will be the adjustment of fund regulations. Recent proposals put forward to protect the funds from panic selling include a longer withdrawal notice period required for larger amounts of investment, and maximum payments to each investor in difficult periods.

So far, actions taken by fund managers have ensured that investors have realised minimal losses and dividends for the most part have been unaffected. When turning again to the 2005/2006 situation, frozen investors at that time still managed to achieve relatively high returns. This is a time for investors to hold tight. Source.

A fairly well written argument arguing for commercial property fund investors to hold tight because these funds are a fundamentally sound long term investment. But, and this is a rather large but - this article was not written by an impartial journalist, it was written by Timo Tschammler, managing director of international investment at DTZ, a “real estate advisor.”

It is very much in DTZ’s interest to persuade investors in commercial property funds to leave their investment in place, not because it is in the best interests of investors, but because any more withdrawal of funds will be a major issue for DTZ. their shares have fallen from a one year high of £279 and are currently trading at around £28. A drop of almost 90%. This down from a recent high of over £800 as recently as 2007.

Quite apart from that, the fact is that the commercial property sector in both the UK and the US faces some enormous challenges in 2009 from which I suspect they will not recover from in less than seven years. British commercial loans are set to default to the tune of £70 billion this year, with the Financial Times themselves reporting on the dire outlook, and the US commercial property sector is in even worse condition. I personally see many of these funds failing in 2009.

I am not entirely sure what the FT is doing by allowing this to pass as journalism, but I suspect it is one of the few times where the writer needed to pay to write.

Speaking of The World - The International Herald Tribune reports that Nakheel have so far sold 70% of The World Islands in Dubai. Although, apart from a Belgian Baron planning a boutique hotel, and rumors of a couple of other investment groups, such as an Irish consortium to develop Great Britain and  Chinese consortium to develop China,  much of this development seems to have been sold either to Dubai based developers, or other neighbors. Seeing as Nakheel is government owned, and all the developers are government owned, they have effectively sold it to themselves…..

It looks as though there will be tough new regulations imposed on real estate agents, brokers and lenders in the US - apparently they are the ones to blame for the current crisis - not the governments and central banks for over lending……

This follows on from promises by the UK government for the Office of fair trading to investigate the real estate market in the UK. So it would appear we are going to be even more regulated from the bottom up in the UK. What we really need is some accountability at the top. Fat chance of that. Look forward to more rules next year.

It looks like the luxury property market is in for a rough ride in 2009, and British house prices are set to fall in 2009 - probably even further than in 2008. Spain is probably the worst hit of all the European countries, but property prices are falling in France pretty dramatically as British expats bail out thanks to the value of the pound. The question is - how far will the Euro fall when reality sets in? The Eurozone banks are heavily exposed to eastern European markets and when these loans start defaulting in 2009 and the German car manufacturers realize no one can afford a new Mercedes, who knows?

Commercial property seems to be the next market to be hit, with estimates that British banks are set to lose £70 billion in 2009, triggering another government bailout and possibly the fall of the government? Over the water in the USA, commercial developers are already holding their hands out for government bailouts. I can’t see it myself. At least with the auto industry there is some sort of justification in the form of workers employed, but just to prop up the cost of commercial real estate? Not going to happen. Unless they turn themselves into banks. Although, it turns out that The Treasury Department has already committed $10 billion more than it was authorized to give out. This is what happens when you give some one a blank check book……

If anyone was hoping that China would leap to the financial rescue of the rest of the world, this seems unlikely. With sales of plastic crap from China falling through the floor, the New York Times has an interesting article of one village in China which existed solely to produce crappy knock offs of famous paintings to hang in Motel 6s.The luxury retail world is also feeling the pain, and  Louis Vuitton knockoff bags may be the next new “luxury,” if no one can afford the real  thing any more…….

Happy New Year

Small property investors will be facing an enormous dilemma in the coming years. Who to trust for advice. Very few of the institutions saw the housing bubble coming, and the few that did, mentioned “a small correction, perhaps single digits.”

We are all watching the smaller investor being crushed while the institutional investor gets government handouts, so the market has just become a far less safer place. The big will eat the small, and getting impartial advice in the future will be paramount.

Citigroup as an example - Citi have just dumped $8 billion into infrastructure projects in Dubai, as proof of their “commitment to the UAE market in general, and reflects our positive outlook on Dubai in particular.” But, lets face facts, Citigroup just went broke, and had to beg for a bailout from the US government to the tune of $300 billion. What on earth do they know about property markets? Nothing apparently. If they were an individual investor, they would be fending off bailiffs and transferring the Jag into their wife’s name about now.

Credit Suisse has just reiterated a positive outlook for the UAE real estate sector. With property prices in the UAE falling faster than they rose, and bearing in mind that Credit Suisse has just announced that they will be paying their executive staff bonuses using illiquid and opaque assets, I will be taking everything Credit Suisse says with a very large pinch of salt, and I wonder just exactly how many of those illiquid, opaque assets are tied up in the UAE. They managed to lose billions this year, and oddly enough, when they went looking for funds, Qatar Holding LLC was first in line, buying 93 million treasury shares. Impartial advice? Not on your nelly.

Up-market real estate agents, Savills, have just pulled out of the Hungarian market after less than two years. I am sure they managed to squeeze a few commissions from would-be offshore investors before that particular bubble burst, but proved pretty conclusively their advice is worthless.

Just last month, analysts in Singapore were predicting falls of less than 10% in Singapore property prices, but are increasing that estimate almost on a daily basis.

There is no doubt in my mind that the financial landscape is going to change in the short term future. Just exactly what it will look like is anybody’s guess. Partly dependent on just how many banks the US and UK government will end up nationalizing before the fallout stops. Merely printing money is unlikely to fix the problem. Should be an interesting year in 2009. For now, I am going with the usual maxim. “If it looks too good to be true, it is.” One person who saw this coming, Nouriel Roubini gave an interview in October voicing his views on the next year -

Standard & Poor’s Rating Services said today that it had revised its outlook on Dubai-based property developer Emaar Properties PJSC (Emaar) to negative from stable.

“The outlook revision reflects a rapid weakening of the real estate markets in Dubai, and our uncertainties about the depth of the downturn and the pace of eventual recovery. A prolonged downturn could negatively impact our view of Emaar’s business risk, and it could also lead to deterioration in Emaar’s currently healthy financial position,” said Standard & Poor’s credit analyst Alf Stenqvist.

The ratings on Emaar continue to reflect the group’s important role and strong position in the Dubai property development market and its close relationship with, and 32% ownership by, the government of Dubai (not rated). The rating includes a two-notch uplift from the stand-alone assessment to reflect implicit support from the government of Dubai. The rating also reflects the group’s current strong cash flows, low debt leverage, and strong asset base. Constraining rating factors include the weakening of the Dubai real estate market, the concentration of the group’s operating cash flows in a relatively small number of large projects, and the group’s aggressive geographic expansion into markets with higher political and economic risk. On Sept. 30, 2008, the group had total interest-bearing debt of about UAE dirham (AED) 9.1 billion ($2.5 billion).

Emaar is one of the largest property developers in Dubai, with sales of AED17.6 billion in 2007. The group focuses on residential communities and has until recently benefited from high demand for properties in Dubai, which has been supported by the rapid economic growth of the emirate.

Emaar’s expansion in the Middle East and North Africa has so far offered only a limited cushion against the downturn in Dubai, and the company’s U.S. operations are loss making. Emaar has, however, recently completed a large shopping mall in Dubai, which should generate quite good and stable rental income in the years ahead.

The negative outlook reflects the weakening of real estate markets in Dubai, which if prolonged and more severe than we currently anticipate, could put pressure on Emaar’s cash flows and financial position, and subsequently could lead to a downgrade in the medium term.