Both banks and open end real estate funds effectuate liquidity transformation
in large amounts and high scales. Because of this similarity the latter should
be analyzed using the same methodologies as usually applied for banks. We
show that the work in the tradition of Diamond and Dybvig (1983), especially
Allen and Gale (1998) and Diamond and Rajan (2001), provides an applicable
theoretical framework. We used this as the basis for our model for open end
real estate funds. We then examined the usefulness of the modeling structure in
analyzing open end real estate funds.
First, we could show that withdrawing of capital resulting in a run is not
always inefficient. Instead, withdrawing can as well be referred to the situation
where the low return of an open end fund unit in comparison to other opportunities makes, (partial) withdrawal viewed from the risk-sharing perspective optimal.
Even with costly liquidation, this result will hold, though we will have deadweight
losses in such a situation.
Second, introducing a secondary market in our model does, not in general,
resolve the problem of deadweight losses associated with foreclosure. If assets are
sold during a run, we do not only have a transfer of value but it can also create
an economic cost. Because funds are forced to liquidate the illiquid asset in
order to fulfill their obligations, the price of the real estate asset is forced down
making the crisis worse. Rather than providing insurance, such that investors
receive a transfer in negative outcomes, the secondary market does the opposite.
It provides a negative insurance instead.
Third, our model proves that the open end structure provides a monitoring
function which serves as an efficient instrument to discipline the funds management. Therefore, we argue that an open end structure can represent a more
adequate solution to securitize real estate or other illiquid assets. Instead of
transforming open end in closed end structures, fund runs should be accepted as
a normal phenomenon to clear the market from funds with mismanagement.