A note from the European Central Bank (ECB) earlier this month raised fears that the liquidity mismatch of real estate funds could create serious shockwaves across the global economy, should nervous stakeholders initiate a run on redemptions. Hospitality investors may have instinctively looked across the pond at Blackstone’s Blackstone Real Estate Income Trust (BREIT), which has proved the canary in the coal mine in recent times for impending liquidity risks.
It was BREIT which, towards the end of last year, spooked investors as it sold stakes in two Las Vegas hotels, the Mandalay Bay and the MGM Grand, in a deal which valued the properties at a healthy $5.5 billion, but nevertheless signalled that a liquidity crunch was on the way. At the time, the sales meant a profit of more than $700 million for Blackstone in less than three years, but were also a response to the sharp increase in interest rates, making assets with fixed returns less interesting, and requiring a greater proportion of liquidity to respond to the evolving tastes of investors in BREIT.
Withdrawals from BREIT have now been capped for six consecutive months, initially at 2 per cent of the fund each month or 5 per cent a quarter. However, as the fund hit the 2 per cent threshold in January and February, it was reduced to 1 per cent in March, the last month of the quarter, suggesting that liquidity issues are not going away.
Redemption trend
A hotels investment consultant told Hospitality Investor: “We are monitoring the current situation pertaining to gating, pro-rata redemptions or suspension of redemption mechanisms which are affecting the real estate fund industry overall. This is not an unprecedented situation – back in 2008/2009 pretty much all illiquid hedge fund strategies were affected by similar issues.
“In most cases, fund managers have acted in accordance with the offering documentation and regulations. In addition to allowing managers to impose liquidity gates they are also often given explicit permission to further restrict redemptions if they are of the opinion that the price they could achieve in the market is distorted due to fire sales.
“Ultimately, and certainly not for the first time, investors have invested in a fundamentally illiquid asset class with the illusion of liquidity at any time. Investors will have to learn again about liquidity mismatches.”
Asset performance
Hospitality fund managers might hope to have a more phlegmatic brand of investor on their hands, due to the comparatively strong performance of hotel assets in recent times, which have often produced positive returns in the past 6-12 months compared to other asset classes. A new report from CBRE underlines that global hotel performance metrics should return to pre-pandemic levels in 2023, with RevPAR in the Americas already having exceeded 108 per cent of pre-pandemic levels in 2022, which Europe virtually on par at 97 per cent. The report shows that ADR growth is fuelling overall performance, which is expected to help offset supply chain and labour shortages which have kept expenses high. Paris continues to shine with the impending Rugby World Cup in the autumn and the Summer Olympics in 2024, but plenty of other European hotspots are outperforming, particularly in the Mediterranean. Continuing waves of US travellers plus the easing of restrictions on Asian tourists all suggest that summer 2023 will be a positive one for the region.
Open-ended risks
Sentiment is important, as plenty of hotel funds in Europe are open-ended in style, meaning that investors can give a minimum amount of notice if they want to withdraw their money. Several German fund managers, from Union Investment Real Estate to Quadoro all hold hotels in open-ended vehicles. Indeed, it is this kind of fund structure which comes under the spotlight in the ECB report, which points out that open-ended real estate investment funds (REIFs) account for 80 per cent or €835 billion of the NAV of all REIFs. The report notes that these funds are primarily located in five countries, namely Germany, Luxembourg, France, the Netherlands and Italy, which account for most of the growth in the sector, but therefore have a significant role in the real estate fortunes of each country. The report adds: “In several euro area countries, notably Luxembourg, Ireland, the Netherlands and Portugal, the real estate assets of REIFs represent over 30 per cent of the value of the national CRE market.” Beyond national borders, the ECB paper also points to the interconnectedness of the euro area, and the risk that repricing becomes contagious across borders.
Despite much of the literature examining the risks surrounding open-ended vehicles, the hotels investment consultant doesn’t think that the current “crisis” is a matter of seeking out “superior fund structures”. He adds: “At this point, it’s a matter of communication, transparency, and expectation management. If history provides any guidance, I expect liquidity gating to be an issue for longer than we expect. Not because of fundamentals, but because investors may now over-redeem to jump the redemption queue. This will likely lead to a self-fulfilling prophecy of further redemptions.
“The winners, as unlikely as it seems, are likely to be the fund managers which communicate openly and transparently but are aggressive in their gating and possibly stop redemptions altogether.”
He backs this thesis by pointing to the wake of the Global Financial Crisis, where “the fund managers trying to return as much money as possible were often wiped out or had to sell at low prices, ultimately destroying their track records once and for all, while the ones imposing liquidity restrictions often came out as winners”.
Looking at the issue of ongoing interference from a jittery ECB, a paper just published by ING Bank suggests that short term financial stresses could actually “de-stress” the ECB in the long run. Authors Bert Colijn and Carsten Brzeski argue that peaks in systemic stress generally result in recession and lower inflation down the line, making the work of the European Central Bank easier. “So far, we have not seen stress reach worrying levels, meaning that we expect the ECB to continue to hike at the next two meetings,” the paper says. Essentially, if the economy and thus inflation continue to surge ahead, the bank has its work cut out, while recession and contraction allow the institution to ease off. Perhaps an angsty ECB is a good sign, after all.