The European Central Bank called for a crackdown on commercial property funds in order to reduce the risk of a downturn within the EUR1tn sector triggering a liquidity crisis. Investors could rush to withdraw their money if this happens.
The ECB’s proposals are a reflection of investor and regulator concern that recent banking turmoil could exacerbate tensions in the commercial real estate market, and push the sector closer towards crisis.
Funds that invest heavily in illiquid assets that allow investors to withdraw their money quickly are at risk of a liquidity mismatch that could lead to “fire sales”, ECB officials warned Monday in a macroprudential bulletin.
The officials stated that policies should be created to address the “structural vulnerabilities” of these open-ended property funds “given their risks to the commercial real estate market and wider financial stability”.
According to the report, the “clear indicators of vulnerability” were “declining liquidity in the market and price corrections driven largely by uncertainty about the macro-financial outlook as well as monetary tightening.”
The MSCI Europe Real Estate Index of large- and mid-cap properties fell by 14% in March, close to the lowest point since early 2009.
After a spike in investor requests to withdraw money from its $125bn fund, the ECB cited Blackstone Real Estate Income Trust’s recent decision to limit investor redemptions. The ECB also mentioned that the UK property funds imposed limits on outflows following last year’s “mini Budget” resulted in a sell-off of gilt markets.
According to the report, tighter rules will allow property funds “manage spikes of liquidity demand and to internalise redemptions costs that can arise during market stresses”. The report also stated that funds without adequate liquidity management tools could resort to asset fires to increase market stress.The ECB proposes a number of measures, including reducing investor withdrawal frequency, giving investors longer notice and imposing longer minimum holding periods.
The ECB called for uniform application of rules on properties funds throughout the 20-country Eurozone. Funds should charge fees on investor redemptions, and impose “gates”, to limit outflows.
“On the assets side,” officials suggested that a policy to increase the liquid assets could be considered, as it would reduce liquidity mismatch. They also stated that such measures would help the sector cope better with market stress.
According to the ECB, the net asset value for real estate investment funds has more that tripled in a decade. It grew from EUR323bn during the fourth quarter 2012 to EUR1.04tn during the fourth quarter last year. These funds now account for 40% of the eurozone’s commercial property markets, with around 80% being open-ended.
The report stated that transactions in the commercial property sector of the eurozone fell by 44 percent in the last three months of 2018. The prices of prime office property in the bloc dropped 14 percent in the second and three quarters of 2022, compared to the previous year.
According to the ECB, the use of property funds as debt would increase losses for investors in a downturn and increase the contagion risk of any banking crisis.
The Financial Stability Board is a group of top policymakers. It stated in December that there has been “no measurable decrease in the degree structural liquidity mismatch” since 2017.