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In August this year, Reita released its quarterly expert panel survey results which looked at reasons for volatility in property company shares. The results revealed that 60 per cent of the panel of senior industry executive said they thought that volatility due to short selling was a major issue. However, the report concluded that, while short selling was unsettling in the short term, in the long run it had no effect.

This all seems a long time ago now. Not only have we seen unprecedented volatility in stock markets over recent weeks, but also the emergence of a new bogeyman - following the failure of Lehmans and the forced marriage of HBOS. The so-called short-selling “spiv” was suddenly charged, by some sectors of the media, with bringing the world’s banking system to its knees as a wave of hysteria took over. Pleas for the practice of short selling to be outlawed were answered in many places; in the UK a list of 34 prohibited financial stocks was created and a furious debate has raged ever since on the merits and de-merits of shorting.

But, if shorting is supposed to be a global problem, then there certainly hasn’t been a consistent response across financial markets. Reactions have ranged from a complete ban in Australia, a prohibited list of 900 stocks in the US, and the Chinese Securities Regulatory Commission are reported to be bringing in plans to permit short selling to “boost trading without inciting further declines in the market”.

In the US, the heart of the global financial system, the prohibited list, for the moment at least, is constructed on the principle of requesting inclusion and this perhaps highlights the nub of the issue. Why should a company seek, or be afforded, protection from a legal and indeed logical investment technique?

If you believe the outlook is gloomy and shares are likely to fall in price then going short makes sense and indeed provides liquidity into the market, where other investors may not share your views.

However, while the risks in going long (buying shares and holding on to them) are limited to the funds that are invested in the shares, the risks in shorting are open ended - as there is no limit to the price to which shares can rise. If this scenario is wrong and shares rise rather than fall, then the “punter” will still have to pay up to acquire the shares needed to complete their trades. This is particularly likely to be a risk where short sellers provide the momentum behind the falls in a share’s price, and also where sentiment, rather than reason, is driving prices.

The case the regulators have put is that where there is a period of exceptional instability (and we have certainly been experiencing one for the last few weeks), organisations whose survival as going concerns depends on public confidence, and which in turn play a key role in the normal functioning of the financial system, should be supported by additional scrutiny of activities that might reduce public confidence. If these activities are judged to be against the public interest then they should even be prohibited. The more moderate of those who advocate a ban say that it should remain in place only as long is it does more good than harm, though opponents of the ban query whether shorting actually does drive down prices more than bearish shareholders’ desire to sell.

The effect, of course, of a ban on shorting is to reduce the level of activity in the market and the intention is that this will reduce levels of volatility. However, the cost is that levels of liquidity are reduced simply because the numbers of sellers and buyers are also reduced. In markets where all shorting has been banned this can have potentially very serious effects. For example, according to Data Explorers in Australia, the short selling ban has resulted in some hedge funds being almost frozen, although this may of course have been the intention. However, the volume of trading on the ASX has also taken a hit, with cash equity trades down by more than 100,000 on some days during September.

What has this got to do with property companies and, particularly, Reits? These are not banks and do not rely upon public confidence for their short-term survival as they are underpinned by high-quality physical assets and steady income from long-term leases matched by secured and relatively low levels of borrowing controlled by UK Reit legislation. Reits really should be boring stocks that produce steady income for investors with some capital growth, yet they have been the subject to unprecedented volatility over recent months. EPRA indices have been established for 18 years and in that time there have only been 22 moves up or down of more than 4 per cent in one day. Eighteen of these have occurred since July 2007. Nor is this simply the result of previous over pricing being corrected, since 14 of the 18 moves were upwards.

There are probably three main reasons for this volatility in the UK. First, most investors in UK Reits and property stocks are short-term generalists and indeed many view these holdings as closely related to financial stocks given the property companies’ requirements for capital intensive investments - so concerns and movements in the capital markets are reflected in movements in Reits. Second, to quote Harm Meijer, JP Morgan’s leading property analyst, “Increased volatility is - for a large part - a function of increased risk and are we not in a major financial crisis?”

Third, to judge by the high levels of stock lending (illustrated by anecdotal evidence from property company executives and, for example, up to almost 30 per cent of Liberty International in July), there is some significant shorting taking place; both as an element of longer-term investment strategies and probably by those seeking to actively exploit short-term opportunities.

Share price volatility presents two problems for Reit managers. First, it is a distraction from their core business of managing long-term property businesses and will tend to deter long-term investors from entering the sector. Second, were there to be a sustained period of shorting focused on one or two particular stocks then it is possible that investor confidence in that company would be shaken to such an extent that its future survival as an independent entity could be threatened. This latter problem explains the concerns voiced that the ban on the shorting of financial stocks could result in a switch in focus to property sector.

However, this has not yet happened and concerns in the property sector are rightly more focused on some of the highly geared private companies. UK Reits, in contrast, can, according to Mr sMeijer, “use their financial strength and expertise, to play a significant and positive role going forward, by assisting banks with cleaning up their balance sheets, picking up assets at ‘cheap’ prices, and perhaps contributing reasons why rates should be cut.”

Volatility, whether due to short selling or investor nervousness, is a major concern and will remain so until it is clear that we are getting the current financial crisis under control. Short selling will remain one of the factors that contribute to volatility and the FSA is evidently cognisant of the need to be vigilant for any signs of market distortion. However, the continued drive towards ever greater transparency, which Reits are leading in the property sector, is likely to be the best long-term defence - allowing the full range of investment techniques to be deployed to maintain liquidity and market development.

Dave Butler, head of external affairs, Reita