Market conditions have made pension funds more acutely aware of the logic of taking a conservative approach to leveraging. Richard Lowe reports

Fred Green
Head of investment
Teesside Pen sion Fund
TOTAL ASSETS: £1.7bn (€2bn)

Fred Green, head of investment at the Teesside Pension Fund, admits that the current downturn has made the UK institution more cautious about leverage levels in real estate investments. But he says the pension fund has always taken a conservative view.

"I am not a great believer in massive leveraging, and I don't say that with the benefit of hindsight. We have had that view for quite a few years," he says.

Even so, Green admits that "leverage is perfectly proper and appropriate provided it is understood, controlled and the risks are understood as well".

The fund is currently focusing on direct investments, with no leverage, in its domestic property market. But it also invests indirectly through funds, and aims to gain exposure to Asian real estate markets when economic and financial stability returns.

In terms of indirect products on the market, Green reveals that he has seen some with "intriguing projections about returns which are often based on leverage". He adds: "We have historically tended to take those with a pinch of salt… we wouldn't be put off investing in a property fund just because it was leveraged, but we would expect that leverage to be, as I said, understood and controlled."

Green believes that many fund managers are looking to launch funds today with "sensible" levels of leverage; he can think of two recent presentations where the proposed maximum levels were set in the region of 15-20%.

"It is purely a personal preference, but anything beyond that starts to give me cause for concern," he says.

Allan Mikkelsen
Partner, ATP Real Estate
TOTAL ASSETS: DKK400bn - (€55bn)
REAL ESTATE ALLOCATION: Undefined (approximately 5%)

Debt has done quite a lot of harm now in these down markets and we see managers spending a lot of time on managing debt instead of managing real estate. This is always the way it is in crisis situations," says Allan Mikkelsen, partner at ATP Real Estate, the property investment management arm of Danish pensions giant ATP.

Mikkelsen hopes to see a return to the traditional role of institutional real estate ivestment - that is, a long-term investment with risk-adjusted returns somewhere in the region between bonds and equities.

That said, he also wants to see active management of underlying assets. "We still like to see value being added and there has to be a connection between hard work and returns," he says.

ATP Real Estate's current appetite for leverage levels in funds is 50% on average. "We would encourage the low risk spectrum of real estate to be in the range of 30% in today's market, but also because that is probably what it is realistic to raise," he adds.

"We do see people raising debt or being able to find debt in smaller tranches, maybe even up to 60%, but clearly that is based on a new valuation, so it is taking some of the heat out of the equation."

Jeroen Winkelman
Portfolio manager for European indirect investments
BPF Bouw

BPF Bouw, the pension fund for the Dutch building industry, currently invests approximately 50% of its capital allocated to indirect real estate investments in core funds, with the balance split evenly between value-added and opportunistic vehicles.

This arrangement may have to be adjusted following its decision to change its in-house definitions of fund styles, which are now more conservative with regard to leverage than those of the European Association for Investors in Non-Listed Real Estate Vehicles (INREV). For example, funds previously defined as core with leverage close to 50% will move up the risk spectrum and be regarded as value-add. Consequently, nearly all of the core funds in which BPF Bouw is invested are now considered value-add.

"We redefined core and value-added and opportunistic, because in the Dutch market we work without leverage," says Jeroen Winkelman, portfolio manager for European indirect investments at BPF Bouwinvest, the real estate investment manager for the pension fund. "If you look at it, technically we only have a few funds that are really core, according to our own definitions."

In the future BPF Bouwinvest will focus predominantly on core, income producing funds with "low or no gearing", and is likely to encourage fund managers to reduce their leverage levels in new core vehicles.