It has been an annus horribilis for most property professionals. However, closer examination reveals the odd patch of clear sky in an otherwise gloomy outlook. While most traditional property fund managers have been struggling to cope with collapsing asset prices and a flood of investor redemptions, the reverse is true for property hedge funds.
Given the market turmoil, returns have been respectable and money is continuing to flow into their coffers. While most fund managers consider commercial property to be a good long-term investment, it is a highly cyclical asset class. This presents a problem for long-only funds: even if they know the asset class is on the cusp of a period of revaluation, there is no way to profit from this situation.
Long/short property hedge funds can make money in a falling market, explains Marcus Szemruk at TriAlpha. The investment manager offers a fund of property hedge funds among other types of investment strategies. There are eight underlying property managers in the fund, focusing on the US and European markets.
The key to making money in a declining market is to sniff out those assets whose values will fall and then going short.
"Our managers have a range of investment tools available to them. They can, for example, go short on a particular property index by shorting that index, usually by selling futures. Or they can short a single stock," says Szemruk.
TriAlpha launched its Global Property Strategy Fund in June this year. "Since its launch until the end of October, the value of the fund has declined by 8.8% but the FTSE global real estate index declined by 43% over the same period," he adds.
For some veterans of the property market, it was clear back at the start of January last year that the market’s extraordinary performance was running out of steam.
Marcus Phayre-Mudge, fund manager at Thames River, says: "Although I did not foresee the credit crunch and its impact on the property market, it was clear that the start of last year marked the beginning of a difficult period."
Collapsing investment yields and rising debt costs meant that property deals ceased to make financial sense and it was impossible to find any value in the market.
"After a discussion with a friend, we realized that the best way to make money in those kinds of market conditions was to run a long/short equity fund," says Phayre-Mudge.
| Good time to go short |
| Index level rebased (3 Jan ‘00 = 100) |
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| Source: FTSE Group |
From the seed of that idea, a property fund was born and Longstone was launched in November 2007 with external funds of €14 million. "From launch the fund is up over 8%. The market has fallen over 50% in the same period," he adds. For both Thames River and TriAlpha, identifying those companies that would suffer the most during the current turmoil has been pretty clear cut: there is a group of companies that will survive this turmoil and there is a group that will not.
Phayre-Mudge elaborates: "We have identified those companies that will not survive the turmoil. These are typically companies with too much debt on their balance sheet, which were often companies that had bought long-term property income using short-term debt financing."
While the valuations of all property assets have taken a pasting, there are solid property businesses that will thrive in coming years.
Szemruk at TriAlpha says: "Some property companies with not that much debt on their balance sheets are well positioned to be relatively immune to an economic downturn.
"For example, a company like Shaftesbury that owns much of Carnaby Street will do well over the long term. Companies that specialize in providing homes for the elderly are relatively defensive investments."
Like TriAlpha and Thames River, CBRE Reech uses similar instruments to exploit any pricing inefficiencies it identifies between different asset classes.
As well as going short individual stocks and indices, CBRE Reech also uses property derivatives.
The property derivatives market is much less developed than other derivative markets and there have been concerns that the present crisis could slow its development.
Christophe Reech at CBRE Reech says that property derivatives have been trading well. "The property derivatives market has been doing very well during the current crisis, especially over the last three or four months. We have seen the liquidity of the market continue to grow, very surprisingly."
Reech will not discuss which investment strategies CBRE Reech has implemented to achieve returns of around 9% so far this year. "We do not want to share our trading strategies with the whole market," he says tartly.
All three managers are in agreement on one key issue: all of their funds are being cautiously managed to keep a lid on risk.
Phayre-Mudge says: "We could invest all of our capital, but we’ve currently only invested 60% of our funds. If we can deliver decent returns without using all our funds we’d rather do that and keep back some cash." The level of debt used by all three funds is also currently at minimal levels.
All three are cautious about the outlook for the coming year, warning that things will remain difficult for many more months.
"The commercial property sector partied too hard at the debt rave and it’s still getting over the hangover. But the long-term investment case for commercial property remains intact." says Phayre-Mudge.