Structural risks of real property funds

By Dan Hallett, CFA, CFP on June 22nd, 2010

In a recent Globe & Mail article, I was quoted as saying that I was amazed that real estate mutual and segregated funds still existed.  I was surprised at the extent of feedback I received on this seemingly innocent quote.  But clearly, the firms offering structured real estate investment vehicles are a passionate bunch.  I realized that some clarification and expansion may be of interest.

There are at least a few REITs in existence today that originated as open-ended mutual funds.  Examples of old real estate funds include MD Realty Fund (acquired by Canadian REIT in 1996), Royal LePage Commercial Real Estate Fund (liquidated and wound-up in 2001), Roycom-Summit Realty Fund and Roycom-Summit TDF Fund (both Roycom funds merged and then converted to the Summit REIT in 1995, which became ING Summit Industrial Fund LP in 2007).  [Postscript:  ING Summit was effectively acquired by a joint venture between KingSett Capital and Alberta Investment Management Corp in the fall of 2010.]

The real estate crash of the early 1990s – and the resulting avalanche of redemption requests – forced these funds to go through the kind of freeze that the GWL funds are in today.  In the past, redemption freezes simply preceded conversions to REITs or wind-ups.  Since the GWL-managed funds are all segregated funds, a REIT conversion may not be an option.  Only time will tell if they can satisfy what appear to be limited redemption requests today and if the funds can emerge from their frozen status.

Given how many funds were crunched for liquidity and the severity of the early 1990s real estate downtown, it is amazing that the group of GWL-managed funds (bearing the GWL, London Life and Canada Life monikers) have managed to survive this long without another liquidity crunch.  Standard Life still has a property fund in a liquid structure but it’s not a retail product; it’s part of its group savings and DC product shelf where the flows are much more consistent and assets are stickier.

Having said all of that, I believe that funds investing in property – not publicly traded real estate securities – are better diversifiers of stock & bond portfolios.  But this raises the importance of not only evaluating the money manager and mandate but also the structure within which those elements are housed.

While publicly-traded REITs appear to offer the best balance of liquidity and diversification (because they hold a portfolio of income-producing properties) their shorter-term price behaviour includes a lot of stock market noise.  Balancing a client’s need for liquidity with the nature of the underlying portfolio and potential structural risks is key to selecting the most suitable property fund.