M&G freeze shows winter is here for UK malls, and it's staying

London

WHEN shoppers leave the House of Fraser department store at the Fremlin Walk mall about 50 km south-east of London, they're greeted by an increasingly common sight: a row of empty stores.

The mall is the fourth-largest asset in M&G's flagship £2.5 billion (S$4.5 billion) property fund that was frozen on Wednesday after too many of its investors tried to flee.

Its gating reflects a deepening crisis in the real estate industry: retail properties like the near 15-year-old open air centre have become almost impossible to sell in order to pay back investors.

"I wouldn't say there is a buyers' strike for retail property, that would imply it is going to end one day," said Andrew Jones, chief executive officer of real estate investment trust LondonMetric Property. "This isn't cyclical, it is permanent."

The pain is harshest for landlords like M&G, which has about 40 per cent of its holdings in retail. Its Fremlin Walk flagship tenant House of Fraser is one of dozens of UK retailers that have been forced to close stores and slash rents as they compete with online rivals, sending values into free-fall.

The largest firms closed almost 6,000 stores in the first nine months of this year, a 77 per cent hike on the whole of 2018, according to the Centre for Retail Research.

The crisis has underlined a crucial flaw in these types of property funds. Because clients can exit the investments on a daily basis, the underlying assets can't be sold fast enough to keep pace with sustained withdrawals.

While many managers of real estate funds have built up large cash buffers, a wider lack of liquidity in the asset management industry is emerging as a key risk for investors.

M&G's freeze follows the shock collapse of former star stock picker Neil Woodford's investment empire this year.

The fallout from that has made investors more sensitive to managers who, in their hunt for yield, have holdings of harder-to-sell assets.

"There certainly is a higher probability of other property funds following" M&G due to the illiquid nature of the asset class, said Bev Shah, founder of advocacy firm City Hive. "Any investor should also be aware of the risks of this happening."

Many are aware, and acting fast. Investors have yanked more than £2.5 billion from the nine largest daily-traded UK property funds for mom and pop investors this year, according to data compiled by Morningstar.

Those funds have an average 31 per cent invested in retail properties, ranging from less than 20 per cent in the Legal & General UK Property Fund, to almost 50 per cent for the Aberdeen UK Property Fund.

Sales of UK shopping centres are on track for their lowest level on record this year, according to broker Savills, which estimates that mall rents have fallen by more than a quarter in 2019.

Still, a handful of recent deals have completed at deep discounts, prompting a slew of writedowns as valuers finally have some evidence on which to base their assessments.

St Modwen Properties last month sold three retail properties at 9 per cent below their May valuations, while Blackpool Council bought a shopping centre for less than half the amount paid by its previous owner four years ago.

British billionaire Mike Ashley bought the Brookfield Shopping Park for £25.4 million in October, a third of the price paid by JPMorgan Asset Management in 2015.

Some funds are making headway selling off their retail property holdings. Aberdeen's fund has several properties under offer, in an active move to reduce its exposure to the sector, according to its latest factsheet.

Still, it's likely to be a steep uphill battle.

"It would be extremely difficult to liquidate that level of retail exposure in the current market," Mr Jones said.

Investors have been here before. A string of property funds - including M&G - were forced to gate after the Brexit vote in 2016, with managers under pressure to sell what they could as fast as possible.

That meant disposing of warehouses or London offices that remained attractive despite the political uncertainty, pushing up their relative exposure to retail.

The run on property funds in 2016 prompted the regulator to introduce new rules that will come into force next year, encouraging managers to hold more cash and to better highlight the potential for fund freezes. It seems the industry hasn't given up on mom-and-pop investors just yet.

"It would be very easy for the Financial Conduct Authority to say they can't invest in commercial property via open-ended funds because we want retail investors to get money out at the drop of a hat," said Andy Bell, chief executive officer of investment platform AJ Bell. "That would be a travesty as far as I'm concerned." BLOOMBERG