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The Discount to NAV of Distressed Open-End Real Estate Funds

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Abstract

This paper examines the discount to NAV in the context of distressed German open-end real estate funds. This is a unique setting to study NAV discounts because distressed real estate funds are forced to sell off their property portfolios and pay out the proceeds to investors. In contrast, the discount to NAV of closed-end funds or REITs can theoretically persist forever. This enables us to study how investors price the risks associated with the forced liquidation of direct-property portfolios. Our hand-collected dataset covers the complete crisis and post-crisis period from October 2008 through June 2016. Using panel regression methods, we find that the discount to NAV is driven by fundamental risk because it is positively correlated with a fund’s leverage ratio and it decreases with the share of liquid assets. We also provide evidence that the discount is related to conflicts of interest between investors and fund management. Besides these fund-specific factors, we find that NAV discounts are driven by spillover effects from the announcement of other funds’ liquidations, as well as by investor sentiment, which is proxied by the aggregate level of capital flows into the industry and by the degree of macroeconomic uncertainty.

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Notes

  1. See Downs et al. (2017) for a recent overview.

  2. See Weistroffer and Sebastian (2015) and Fecht and Wedow (2014).

  3. M&G Property Portfolio, Henderson UK Property PAIF, Standard Life UK Real Estate Fund, Aviva Investors Property trust, Columbia Threadneedle UK Property Authorised Investment Fund (PAIF), Pramerica Property Investment, Canada Life UK Property Fund, and Aberdeen UK Property Fund.

  4. The next section provides some regulatory background on the liquidation regime of German open-end real estate funds and an overview of the recent crisis.

  5. At the beginning of our sample period in October 2008, all German open-end real estate funds had a total fund size of EUR 107 billion. The asset class is divided into open-end real estate retail funds and institutional funds (“Spezialfonds”). In October 2008, the overall number of German open-end real estate retail funds was 43 with a total fund size of EUR 84 billion. Excluding semi-institutional funds, there were 24 retail-focused funds with a total fund size of EUR 69 billion. In total, 10 became distressed in the aftermath of the financial crisis. The total fund size of the distressed funds in October 2008 was about 30 billion Euros. The distressed funds in our sample therefore represent a significant part of the German open-end real estate fund industry.

  6. During normal periods, NAV per share is measured on a daily basis and changes for example as rental payments are received, interest payments are made, or properties are reappraised. The accounting standards with respect to the daily calculation of NAV per share are not lowered as funds suspend the redemption of shares or enter the stage of fund liquidation.

  7. Nine of the ten closed retail funds were relatively comparable to each other. However, the HansaImmobilia Fund was liquidated without adhering to the closing period of twenty-four months. We exclude that fund from our dataset. Moreover, we do not consider the UniImmo Global fund, which closed only temporarily until the revaluations of the fund’s Japanese properties was finalized. This revaluation was necessary due to the Tohoku earthquake and the resulting tsunami as well es the following nuclear risks in 2011. The funds in our sample are predominantly aimed at retail investors, which represent about 60% to 90% of the assets under management. However, as with common mutual funds, institutional investors also have the opportunity to invest in these funds. In fact, institutional investors often have the ability to buy fund shares directly from the fund without paying a transaction fee. In Germany, there are two other forms of open-end real estate funds: 1) institutional real estate funds, which are exclusively aimed at institutional investors. For these funds, data availability is very scarce. And 2) semi-institutional real estate funds. These funds operate according to the same regulatory regime (e.g. NAV-based pricing system, reporting requirements, etc.), however, only institutional investors or qualified investors (high net worth individuals), with minimum investment amounts from EUR 10.000 to EUR 1.0 million are allowed to invest in these funds. While we do have data on these funds, their nature is very different from the funds that are the focus of our analysis, where the supply and demand of fund shares on the secondary market, and, hence, ultimately the discount to NAV per share, is determined by the unwillingness of retail investors to go through the liquidation process. Therefore, we do not consider them in our sample.

  8. It is important to note that our analysis deliberately focuses on distressed funds. Only funds in this subsample can exhibit a discount to NAV. In contrast, investors in non-distressed funds can sell their shares back to the fund at the NAV per share. For this reason, non-distressed funds cannot exhibit a discount to NAV, which makes them irrelevant for our analysis. For this reason, our analysis is naturally restricted to distressed real estate funds. Our results are therefore unlikely to suffer from sample selection bias or endogeneity issues.

  9. As a consequence of the open-end real estate fund crisis, the regulatory regime was modified several times. However, our analysis is unaffected by these changes because all the funds in our analysis were liquidated under the prior investment laws (InvG, effective from 1/1/2004 -7/22/2013).

  10. Table 1 provides the exact dates of all the major events for the distressed real estate funds in our sample.

  11. In contrast to common stocks and mutual funds, there is no public market for the real estate assets alone.

  12. The full list can be found at: www.policyuncertainty.com/research.

  13. Shares of German open-end funds trade on all major German stock exchanges (Frankfurt, Berlin, Düsseldorf, Hamburg, Munich, Stuttgart), except for Xetra. The NAV discounts calculated in this paper are based on closing share prices from the Hamburg stock exchange. Hamburg stock exchange was the first exchange that introduced the trading of investment funds in 2002. Until today, Hamburg is clearly the leading exchange for open-end real estate fund shares as measured by trading volume, enabling it to provide the highest liquidity.

  14. According to an order of the German Central Bank in 2013 extraordinary payouts of distressed funds have to be considered as capital outflows (BVI, 2016). In contrast, we do not consider extraordinary payouts of distressed funds as capital outflows in order to distinguish between real capital outflows and inflows, as an indicator of investor sentiment.

  15. Time-fixed effects enable us to control for any unobserved time effects. However, the time dummies also cause identical regression coefficients for the fund-specific variables across all three specifications. In the next chapter, we describe a method to analyze the goodness of fit for each specification.

  16. As a robustness check we examine the impact of the share of lease terms ending in the short, mid, and long term as an additional proxy for the portfolio quality. However, none of these variables had a significant impact on the discount to NAV. The results are available from the authors upon request.

  17. Moreover, we examine potential spillover effects on funds that are not distressed. In particular we examine the relationship between the total fund flows into all non-distressed open-end funds and closure or liquidation announcements of distressed funds. In untabulated results we calculate the correlation coefficients between our contemporaneous and lagged spillover variables and all asset class fund flows into non-distressed funds. While most correlation coefficients show the expected negative sign, only the correlation between fund closure announcements and fund flows in the same period is statistically significant at the 5%-level with a correlation coefficient of -0.34.

  18. In untabulated results, we find a positive relationship between the VIX Europe and discounts to NAV when we run the regression without the Policy Uncertainty Index.

  19. The regression results are available from the author upon request.

  20. We thank an anonymous referee for drawing our attention to this important question.

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Authors and Affiliations

  1. IREBS International Real Estate Business School, University of Regensburg, Universitätsstraße 31, 93053, Regensburg, Germany

    Sebastian Schnejdar, Michael Heinrich & Steffen Sebastian

  2. Ecole Hôtelière de Lausanne, HES-SO, University of Applied Sciences Western Switzerland, Lausanne, Switzerland

    René-Ojas Woltering

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  1. Sebastian Schnejdar
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  2. Michael Heinrich
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  3. René-Ojas Woltering
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  4. Steffen Sebastian
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Appendix

Appendix

Table A1 Influence of land transfer tax on discount to NAV
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Schnejdar, S., Heinrich, M., Woltering, RO. et al. The Discount to NAV of Distressed Open-End Real Estate Funds. J Real Estate Finan Econ 61, 80–114 (2020). https://doi.org/10.1007/s11146-018-9694-8

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