Property trusts, often referred to as Real Estate Investment Trusts (REITs), pool funds from multiple investors to invest in real estate assets. These funds can vary in strategy, ranging from diversified portfolio funds to funds that focus on a specific asset class such as residential buildings or commercial properties like shopping malls or office spaces.
Investing in Australian property trusts has long been considered a stable, long-term strategy. But, like every investment opportunity, it doesn’t come without its caveats. One of the most discussed, yet often misunderstood, aspects of investing in these real estate trusts is the question of liquidity.
At its core, illiquidity refers to the difficulty in quickly converting assets into cash without a substantial change (diminution) in value. Think of it like trying to sell a concert ticket last minute; the closer to the event, the harder it might be to get your money’s worth.
A feature of property trusts is the mechanism of redemptions that allows investors to convert their units in the trust back to cash. Typically, an investor will fill out a redemption form and lodge it with the Fund Manager who in turn will draw upon the cash reserves of the Fund to buy back (redeem) the investor’s units. However, the illiquid nature of real estate can pose a number of challenges, especially where the redemption amount exceeds the cash reserves available to the Manger. In these circumstances, the Manager will typically announce a redemption freeze for a fixed period, or an indefinite period of time. Where this occurs investors are caught in an unfortunate predicament, especially if they have an urgent need for cash.
While property trusts offer diversification and the potential for attractive, reliable returns, the redemption process can be complex and protracted due to the illiquid nature of the underlying real estate assets.
Before deciding to invest Investors should carefully read and understand the redemption policies of any property trust they invest in and in particular be aware of the potential risks and delays involved.
Why Australian Property Trusts and Illiquidity Go Hand in Hand
Nature of the Asset: Real estate, no matter where it is located, is inherently not as liquid as, say, shares or bonds. Selling a property, particularly a commercial one, isn’t an overnight affair. It can take many months of marketing just to find a willing buyer at the price sought.
Market Mood Swings: The wider economic environment plays a very big role. For instance, during the Global Financial Crisis, many investors were taken aback by how challenging it was to redeem their units in Australian property trusts. The market simply didn’t have enough buyers. As they say, when it rains it pours, and so when the market generally, or the REIT market in particular, takes a turn for the worse it is not uncommon to see a rush for the door by investors with the inevitable result that redemptions are frozen.
Redemption Restrictions: Some trusts include specific clauses that prevent investors from withdrawing their money immediately. It’s a safety net for the trust, but can feel like a trap for investors.
Implications of This Illiquidity
Delayed Access to Funds: Imagine needing cash urgently but being told you can only get it in a few months at best. That’s the reality for many unit holders during a liquidity crunch.
Trust Performance: If a trust has to sell properties in a hurry to meet redemption requests, it might not get the best price. This might materially reduce the amount of cash available to meet redemptions and in some circumstances may even trigger insolvency.
Pricing Ambiguities: In a market downturn, the reported net asset value (NAV) of a trust may not accurately reflect the real market value of its properties, especially where the Manger is a forced seller.
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