UK – Cardano has warned against investing in real estate strategies that focus on long leases and, more specifically, ground rents, on the assumption they represent an effective means of hedging inflation.
The advisor and fiduciary manager argues that "support for ground-rent investments is misguided" at a time when interest from UK pension funds in long-lease and ground-rent funds appears to be on the increase.
Phil Page, client director at Cardano UK, said: "At the moment, there seems to be enthusiasm for ground-rent investments, with some advisers actively encouraging pension-fund trustees to look seriously at these assets as a way of achieving inflation-linked returns.
"The idea being that ground-rent charges on properties should increase in line with inflation. Whilst this may be true, we think that these investments have some common drawbacks that outweigh the inflation-linked benefits."
Page said he also questioned whether the ground-rent market in the UK was "of sufficient size to justify interest from pension funds". He explained: "The total capacity for institutional ground-rent investments is only a few hundred million pounds a year, which is around 0.02% of the assets of corporate UK pension funds collectively."
Page added: "Ground-rent investments tie up assets for the long term, but don't offer very high expected returns. In contrast, if you want to protect explicitly against rising inflation you can do so quite simply with inflation swaps without tying up assets."
Cardano has a more positive view on long-lease real estate strategies that don't invest in ground rents, which have also attracted attention.
"The size of the long-lease market is much larger and the yields are higher than ground rents," Page said. "However, for pension fund clients who are concerned about managing their funding deficit over the shorter term, we think there are more reliable and accurate ways of generating returns and controlling the funding situation."
Richard Urban, property investment manager at Cardano, said he saw better real estate opportunities outside long-lease strategies, particularly strategies that capitalised on "forced deleveraging" by acquiring properties through either "debt or equity ownership".
He said: "We are particularly interested in strategies that identify properties in good locations, but where the seller is disenfranchised and/or is being forced into selling."
However, Greg Wright, director in the pensions investment advisory business of KPMG, said it was "unhelpful to play one [type of property investment] against another as a good or bad idea".
He added: "Long-lease/ground-lease is all about harnessing an illiquidity premium to harvest secure cash flows, which are helpful to meet cash flows out from longer dated liabilities.
"The other property opportunities are quite different. One is about return, exploiting forced sellers. The other is a short-term credit-market opportunity caused by withdrawal of bank financing.
"We actually support all three ideas and see no conflict in this, as they are performing different roles in a porfolio."
Urban also said real estate debt investments – particularly the purchase of existing debt rather than originating new loans – were more attractive than long-lease strategies.
"Our secondary loan purchases have been predominantly in the US, where the strategy is either to resolve the loan through discounted pay-off or enforcement," he said.
"In the UK, where we do have exposure to UK loan origination, it is in development lending rather than the more popular senior lending to core property."
