Cohen & Steers: ‘Open-ended property funds have had a free lunch’

buildingOpen-ended property funds have had “a free lunch” since the financial crisis and when interest rates rise “smart investors will take out their money first”, says Rogier Quirijns, portfolio manager at Cohen & Steers.

Quirijns warns open-ended direct property funds are too focused on UK commercial property and retail investors have piled into the funds as they are “not well educated in real estate investment trusts”.

“There will be a gradual structural slowdown in direct property Oeics,” Quirijns says. “Will people get smarter? If the education is there, capital will flow out of open-ended funds. We could get a run on the funds if they start showing poor numbers or when the free ride of low rates is over.

“Money will reallocate to other areas where there is underlying value creation. Once people find out the smart people will take out their money first. There is more money in open-ended funds now than before Brexit, which worries me. The listed market is never a forced buyer or seller. These guys are. Following Brexit we saw forced sellers in direct property. People didn’t really panic but they didn’t know the metrics of the underlying income that well.”

Quirijns co-manages the Cohen & Steers European Real Estate Securities fund, which invests in listed Reits and other real estate securities that own or develop properties. The manager says he is cautious on the open-ended direct property funds that are overweight to sectors such as London offices and UK retail, where he has almost no exposure. The trust’s only exposure to the UK is in alternatives. Logistics makes up 10 per cent of the portfolio, self-storage 7 per cent and healthcare 5 per cent. In total, the fund’s UK exposure amounts to 30 per cent.

“Retail property is the elephant in the room,” Quirijns says. “It is facing headwinds from e-commerce and there are structural challenges in rental growth. British Land and Hammerson, which own prime retail, are finding it very challenging. The sector is ex growth. A lot of retail direct property funds invest in lower quality sectors than the listed market and they are not getting income and growth.

“We are focusing on total return. Logistics is offering 3-5 per cent rental growth with a 4 per cent yield, which is an 8-10 per cent total return. Offices are on a 4 per cent yield with no growth. Retail is on a 5 per cent yield with no growth and maybe a decline. That is around a 500 basis points difference on return. And that’s not even talking about the illiquidity of the fund. Open-ended funds have around 30 per cent in cash because of regulation. I am always fully invested; it’s what I’m paid for. All Oeics look a bit similar.”

Quirijns argues Reits are not as volatile as they are made out to be and says investors need to take a longer-term view.

“A lot of people say Reits are volatile but that’s nonsense. Investors need to have a three-year horizon. They shouldn’t compare on a three-month basis with real estate. Open-ended direct property funds are a false indicator because of smoothing; they lag the market slowdown. Reits are a leading indicator.”