(Bloomberg) -- After trying and failing to sell office buildings from Paris to Frankfurt, Amundi SA is finally nearing a sizable disposal that will help raise cash for investors who want out of its property funds.
Blackstone Inc. agreed to buy a group of business parks for €250 million ($270 million) to €300 million from Europe’s largest asset manager, according to people with knowledge of the matter. The US investment firm is betting some will have a more profitable future once they’re turned into dedicated logistics facilities, the people said.
The deal highlights an increasingly critical dilemma for open-ended property funds in Europe, investment vehicles that oversee some €166 billion in assets. In a world where office buildings are out of favor, one of the few ways to meet redemptions is to sell other, more attractive assets, such as residential buildings, warehouses or properties than can be transformed for such uses.
That’s leaving fund managers — and their remaining clients — with an increasing concentration in beaten-up segments of the market. With redemptions continuing, some of them may soon have no choice but to sell, triggering revaluations and delaying any nascent market recovery, with potential ripple effects across the economy.
For some property funds and developers, “the pressure to sell is insanely high,” said Henning Koch, the chief executive officer of Commerz Real AG, a German fund manager that oversees about €34 billion in real estate and renewables. “Funds are struggling with outflows.”
Open-ended property funds in Europe have seen six consecutive quarters of outflows, according to Morningstar Inc. The data showed investors have pulled more than €12 billion since the European Central Bank began raising interest rates in July 2022, leaving net assets at the lowest level in five years.
For mutual funds that invest in stocks or bonds, such redemptions would be painful but they wouldn’t create liquidity or concentration issues because the securities are regularly priced on a public market and sold easily. Property funds, by contrast, buy large assets that can’t be traded speedily and whose current value can be difficult to ascertain until they’re sold again, sometimes at significant discounts to what the fund had ascribed to them.
For open-ended funds, that can make it difficult to sell assets when investors want out, creating a potential liquidity mismatch. About €74 billion of commercial real estate deals were completed in total in the first half of this year in Europe, 42% below the five-year average, according to Savills. If funds do sell, it’s easier to dispose of properties where there are better prospects for rental growth and delay revaluing the less popular assets.
In Germany, many funds are struggling to offload assets because of rules that prohibit them from selling assets significantly below book value. If they do, they’re required to reassess the portfolio or property for sale, which can trigger steep changes in the fund’s value. Some managers are currently considering securing new credit lines from their banks for real estate they own to avoid revaluations of the assets and potential sales, two people with knowledge of the matter said.
Others recognize the pain. Union Investment cut the net asset value of a €4 billion fund by 17% last month, after it was unable to sell properties at book value to meet redemptions. Commerz Real wrote off a €50 million investment in the Elbtower project in Hamburg after the developer behind the project went bankrupt.
Exactly how far the asset values published by real estate funds deviate from the actual prices their properties could fetch is anyone’s guess, particularly when it comes to offices, where there’s been a dearth of sales. But a look at publicly traded real estate investment trusts, where investors express their views on the property market daily by buying or selling shares, suggests the discrepancy is substantial. Such REITs have lost about 29% since early 2021 even after starting to rebound recently. Net asset values reported by open-ended funds, by contrast, have barely moved.
The European Central Bank warned last year that problems at property funds could amplify the risks from a commercial real estate market crash. The fallout from the market downturn, which has already ensnared properties ranging from office towers in Hong Kong to apartment complexes in California, could have significant effects on the global economy.
In the 1990s, credit and GDP growth dropped by 12 and 4 percentage points respectively when business property values fell more than 40% in real terms, according to the Bank for International Settlements.
An econometric analysis “suggests a sharp fall in CRE prices this time could have a similarly material impact,” the Basel-based institution said in a report. While the banking system has been resilient so far, “vulnerabilities could become evident if exposures” for everything from offices to stores are “underreported and if prices drop more than expected.”
Already, almost 18% of commercial real estate loans in Europe are classed as stage 2 by banks, meaning credit risk has increased significantly, according to the European Banking Authority, while the non-performing CRE loan ratio at German banks surged to 4.8% in the last year from 2.1% in December 2022. The ECB is expected to push several German lenders to increase their reserves against property loan defaults, Bloomberg News has reported.
Deutsche Bank AG, Germany’s largest lender, last week said it would set aside more money than previously expected for loan losses this year, after it had been too optimistic about a recovery in commercial real estate. The shares slumped as much as 9% on the news, dragging other lenders lower.
Barkow Consulting founder Peter Barkow, whose firm tracks property fund redemptions in Germany, says there could be “further bumps in the road” for property funds even if it’s unlikely to be a repeat of the financial crisis.
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The problems for many of the products have been exacerbated by their failure to pivot away from traditional commercial real estate mainstays like offices and stores and into faster growing segments such as warehouses and data centers.
OPCI funds in France, a popular tax efficient savings product used to invest in real estate, have an average office exposure of 67%, while just 1.7% of their holdings are warehouse properties, according to the Association Francaise des Societes de Placement Immobilier. By contrast, Blackstone’s European portfolio is now 55% warehouses and less than 10% is offices.
Amundi’s deal with Blackstone is part of a wager by the US firm that rapidly rising online shopping will help lure tenants, once the buildings have been upgraded to provide modern warehouse space, the people familiar with the deal said, asking not to be identified because the transaction hasn’t been completed. The properties, which currently comprise uses including office, warehouse and storage space, are owned by a range of Amundi funds including its flagship OPCI product. Amundi and Blackstone declined to comment.
“Funds which got into the market late in the cycle and went for properties in second-tier locations are facing bigger challenges,” said Ulrich von Creytz, Chief Investment Officer Real Estate for Europe at DWS Group, speaking generally about property funds.
“At some stage, private equity may come in to scoop up aging office buildings in second-tier locations such as Frankfurt-Niederrad to replace them, for example, with data centers - and such deals will likely happen at large discounts,” he said.
A number of the international property funds are domiciled in Dublin where the Central Bank of Ireland is curbing the use of leverage by the products at a maximum of 60%, thereby reducing the risk of forced selling when prices are stressed. Funds in several countries also require investors to give them 12 months notice before they can redeem.Many of the French property fund investments are held through life insurance contracts, meaning they aren't likely to be redeemed for several years, according to a person with knowledge of the matter. That provides a source of liquidity and mitigates the risks of outcry from investors who want their cash back quickly, the person said, meaning regulators have been more sanguine about liquidity stresses than they would otherwise be. The Autorité des Marchés Financiers declined to comment.
Some investors are betting there will be buying opportunities once funds can no longer meet redemptions without also selling their less attractive holdings. GoldenTree Asset Management, units of Columbia Threadneedle and the Bhavnani family signed up as anchor investors for a UK real estate investment trust that planned to target “distressed and highly motivated sellers,” including open-ended property funds.
“Redemption requests are in such volumes that the management team believe it is unlikely that many of the larger institutional open-ended real estate funds will be able to maintain sufficient scale, diversification and efficiency,” the prospectus for Special Opportunities REIT said. “This is leading to a forced selling situation.”
For now, however, potential investors weren’t swayed and the planned initial public offering was shelved when fundraising fell short of the target. The management group now wants to use private capital to purchase assets.
--With assistance from Arno Schuetze, Laura Noonan, Steven Arons, Laura Benitez and Loukia Gyftopoulou.
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