It has probably been a good week to have been away nursing my sore gums. Markets have quietened a little and the immediate sense of panic is easing into a time of trying to understand the new landscape, with more detachment and less emotion. 
Less so for property funds.
Their back door has been kicked in and they have been caught in bed with the girlfriend, the loot stashed on the floor. They have been well and truly nicked. And Andrew Bailey hasn’t had his dinner.
Performance of funds in 2016
Source: FE Analytics
2016 is a crisis of funds, not of property. This is a crucial nuance and what we have currently is thus quite unlike either 2006 or 2008.
To understand what is happening in the UK’s property markets (commercial and residential), we need to backtrack over a bit of history. In late 2005 and early 2006 it became abundantly clear that the markets were mis-pricing the risk of commercial property.
Funds were yielding less than gilts, which was simply nonsensical. A significant factor behind this was the use of asset allocation optimizers – spreadsheets that told you that over the past few years commercial property had provided the highest returns, combined with the lowest volatility of all asset classes.
The spreadsheets said that it was not just acceptable, but right, to put 100 per cent of all portfolios into one massively over-valued asset class. It was a classic and completely predictable disaster.
Performance of sector versus indices during the global financial crisis
Source: FE Analytics
The Great Financial Crisis has greater resonance with the present, but is still fundamentally different.
The similarities are a loss of confidence and a lack of liquidity, the separating factor being that of ‘subprime’: banks had invested untold billions into funds worth less that the square root of zip.
This time around, property is not conspicuously overvalued, nor are funds and institutions stuffed with worthless paper.
What we have is a crisis of an inappropriate investment vehicle. Daily pricing and daily liquidity are simply incompatible with an illiquid asset. As ever, no-one worries about this when the money is rolling in. Token noises may be made but nothing ever gets done until it is too late.
That is quite enough pontification.
After a week nursing the scars of my wisdom extraction (yes, I’ve heard all the jokes thank you), my ghast is still flabbered by the market’s treatment of the housebuilders over the past fortnight.
A degree of sense though appears to have returned to the REITs after their initially brutal markdowns.
Let’s start with the housebuilders. These are now typically trading below book value.
Performance of stocks since Brexit Friday
Source: FE Analytics
As a bit of a simplification, this is saying that not only is all their land worth less than the prices paid over the past five years, but also that the operating companies, knowledge and brands combined are worth nothing.
Spin this around and we have an industry with a structural shortage, where the major players are valued at less than their land banks and the operating companies are chucked in for free. Interesting.
Quoted commercial property companies publish asset values twice a year, based, amongst other things, on rental income and a discount rate. In the past month the average (unweighted) fall in the share prices of the REITs is 11 per cent.
There is a fair bit of dispersion around this – the worst is 30 per cent down, the best is marginally up – but 11 per cent is a reasonable indication of the market move.
I find round numbers much easier to deal with, so let’s call this 10 per cent, and split it between a 5 per cent assumed fall in NAV and 5 per cent widening of the discount. If we then apply this back to the open-ended sector, this would mean a 5 per cent fall in the fair value of the units. Compare and contrast with the exit penalties.
The average (again unweighted) dividend yield of the REITs is a little over 4.5 per cent. The yield on the 10 year gilt is, give or take, 0.7 per cent and if the leaks are true, the Bank of England will cut bank rate to 0.25 per cent on Thursday. And sterling assets have just become an awful lot cheaper to everyone else in the world. Very interesting.
Equity indices are again on the up after last Friday’s American payrolls. We distrust that high number just as much as May’s disaster. Markets are hypersensitive in both directions but for the first time in too long there are pockets of genuine value emerging for those prepared to disbelieve the consensus.
We like that.
Jim Wood-Smith is head of research at Hawksmoor and writer of the group’s weekly ‘Innovation’ blog. All the views expressed above are his own and shouldn’t be taken as investment advice.
