The market uncertainty has prompted Danish pension funds to move slowly and carefully. But the signs are that real estate allocations will soon start to rise, as Rachel Fixsen finds

Danish pension funds have long been solid investors in property, particularly within the domestic market. Allocations to bricks and mortar have typically constituted a tenth of all assets at the institutions, but experts say there are good reasons to expect these allocations to expand in the next few years.

The Danish Property Federation has the impression pension funds are looking for more property than before, according to its chief economist Morten Marott Larsen.

"Traditionally, pension funds had 10% of their assets invested in property, but we think it's increasing. This is because real estate is less volatile when you compare it to other assets, especially when you look at some of the Danish property in prime locations compared to shares," he says. The change could become apparent over the next few years.

The Danish residential sector remains broadly under pressure, although there are some positive signs in certain pockets of the real estate market. In the last four years, sale prices for residential property have fallen by 11% to 16% across the country, depending on the type of home, according to information from the Association of Danish Mortgage Banks.

But since earlier this year, rental income in commercial property has improved, the Danish Property Federation has said. And forecasts show urban areas in the big cities are expected to perform particularly well, Marott Larsen says, as more people will move to these locations.

The property investment arm of Denmark's giant ATP pension fund sees the real estate investment arena as tough at the moment because of financing worries.

"It's really becoming challenging right now," says Michael Nielsen, managing partner at ATP Real Estate. "We are rather cautious and that has to do with what's happening in general. We're not sure that funds will be able to get their external financing in place."

For now, institution investors have shifted their focus to Europe to see what is available in the market, Nielsen says. "We are looking for focused managers rather than those that cover the whole of Europe - those that are focused on a clear strategy. That could be single country or a property type," he says.

In January, ATP signed off a further €700m to be invested by its property arm. ATP Real Estate has since committed to three funds: Norden IV, an opportunist fund in Denmark; the ECE European Prime Shopping Centre Fund, and the UBS Trumbull Property Fund, a core fund in the US. Nielsen says this represents approximately 20% of the programme.

Looking at the pension fund sector as a whole, Søren Andersen, CEO of consultancy Invensure in Copenhagen, sees little change to current allocations, but says there are factors at work that could have an impact.

Solvency II could make a difference to allocations, as could the transfer from guaranteed with-profit pension products to unit-linked or life-cycle products - a shift taking place in pension schemes throughout the industry.

"The trend [over] the last five to 10 years has been transferring money from directly-owned Danish real estate to indirectly-owned international real estate," he says. "Due to general market conditions this movement had been somehow slower than originally planned."

The main reason Danish pension funds invest in real estate funds is to obtain diversification on geography, type of real estate and risk level, Andersen says.

"But all the additional costs - and administrative issues - arising from the decision to move from direct to indirect real estate through funds, means the majority of pension funds will continue to have a large proportion in domestic real estate, and actually a larger proportion than they were originally looking for from a theoretical perspective," he says.

Attention is focused on real estate because of the inflation protection the asset class offers. For this reason, Danish pension funds are unlikely to reduce their allocations to property anytime soon, according to Jan Willers, head of financial market research at consultancy Kirstein.

Familiarity certainly plays a role in pension funds' decisions to put their money into the home market. But he says liquidity is another issue when investing directly, and makes the point that fund investments can provide the pension funds with better liquidity.

With the typical 10% allocation to property, AP Pension says the proportion has been stable for several years. While it is still considered to be the right level for the DKK50bn (€6.72bn) independent commercial pensions provider, the fund says it could be increased further. Some 80% of its holdings are in Denmark, where all investments are made directly.

"Real estate is a local business in Denmark. We're so well connected that we can invest in good deals directly," says Peter Olsson, head of property investment at AP Pension. Abroad, however, the institution always invests in funds.

Over the last year, though, the business of sealing property deals has taken a back seat to that of looking after the existing real estate portfolio. "We have been more focused on getting things right, taking care of internal matters in the funds we're already in and optimising the Danish property portfolio," Olsson says. This has involved dealing with issues surrounding tenants and leases, as well as carrying out refurbishments.

Asia remains one of several areas of interest for AP Pension, he says, with growth factors such as the expansion of the middle class and increasing need for shopping facilities conspiring to boost profit prospects in the continent.

"We have been investing in Asia, but you have this question of transparency in Asia, and that is what makes it a bit difficult," he says.

"We're looking at Europe, and also at the UK and the US, but no one wants to catch a falling knife," he cautions. "I can still foresee a lot of consolidation in the market, but further out there are great chances too. If the right opportunity arises, we're always ready to act."

PKA, the administration company that looks after eight Danish pension funds worth around DKK150bn in all, recently said it was aiming to boost its investments abroad, including within emerging markets.

As part of this strategy, it put DKK375m into the SPF II global property fund run by Danish investment manager Sparinvest.

Bo Jensen, managing partner of Sparinvest Property Investors, says that although real estate allocations at Danish pension funds are generally stable, they are probably rising slightly as risk comparisons between asset classes shine a more positive light on property.

"It's the combination of a return where you're paid for the risk - compared with the bond market where you get nothing - and the core asset return," he says.

Despite weakness in the domestic market overall - in common with most markets - Danish property remains attractive for pension funds, says Jensen. "The risk-adjusted return is quite good, and the Danish market is quite small, so it has its limitations. But abroad, there are some positives, particularly in Asia and the US."

When investing overseas, some Danish pension funds are interested in joining forces with other players in potential deals, but this is often easier said than done. "They are looking for this, but it's difficult to do club deals, because you have to find the partners to invest with," says Jensen.

Danica Pension, the DKK280bn pensions subsidiary of Danske Bank, holds all its real estate as direct investments in the Danish market, and has no investments outside the national borders.

Jens Dalskov, head of alternative investment and real estate at Danica Pension explains that this is because property is only one asset class within a globally diversified portfolio.
"We like to have real estate in our overall investment portfolio because of the good diversification, but French, German and UK property doesn't add diversification," he says. That said, this rationale does not rule out investing abroad if warranted for reasons beyond diversification.

"We take a case-by-case look at other countries. If we could see a market that offers more than the Danish market, we would consider investing there. But in the last four or five years, this has not been the case," Dalskov says.

Danica Pension's property portfolio is one of the largest property portfolios in Denmark, making up 10% of overall pension fund assets. "We have chosen investments where we can work closely on each element," he says. "We diversify, hold residential and office, and we also have a number of shopping malls."

Over past 12 months, the property investment team at Danica Pension has focused on attending to the portfolio and the needs that arise in times of economic weakness.

"The downturn in the economy, and the laying off of employees has led to pressure on rents. And, generally in Denmark, 10% of office space is now vacant," Dalskov points out. "We have spent a lot of time in the last 12 months trying to find new tenants for our investments in this area."

Although the fund is still on the look out for opportunities, bargains are hard to find. "Coming out of 2008, the market was very hot, and it was difficult to find a decent deal; that has only gradually changed since then," he says.

Within Denmark, Danica Pension has focused on the major urban centres of Greater Copenhagen and Greater Aarhus.

"In the last 12 months we have made a couple of small and medium scale investments in office buildings, and we have been active in our shopping centre portfolio," Dalskov says. "In 2010 we opened a new centre in Aalborg, and we do have some projects in the pipeline."

In Frederiksberg a construction project is underway which will add to an existing shopping centre, he says. And in Valby in Copenhagen, Danica has a residential property of 7,500sq.m. under construction.

Large-scale retail project
In September Danica Pension took on a large-scale retail project in Copenhagen suburb Høje Taastrup. In conjunction with property company Dan-Ejendomme, the fund is developing a 16,000sq.m. designer outlet centre within the City 2 shopping centre. The outlet centre will house 80 retail units and is set to open in the spring of 2013.

For Sampension, real estate serves both as a generator of return and as a stabiliser compared to the more volatile assets, such as listed equities, the pension fund's CIO Henrik Olejasz Larsen explains. "Long term, it is a good inflation hedge, but not in the short term, particularly if we have an inflation shock," he says.

Sampension's overall allocation to property is the typical 10%, but in one sub-portfolio the proportion has increased slightly as a result of the new lifecycle annuity pension product the institution introduced in 2007.

However, in the remainder of the portfolio Sampension has been decreasing its real estate holdings, because they are non-liquid assets. This has become necessary after the pension fund was forced in 2008 to reduce risk to manage its risk capital situation.

"It actually meant that we first sold the risks that were liquid - primarily listed equity," Larsen says. In fact assets were sold from one portfolio into the lifecycle sub-portfolio, which he says has meant that Sampension has been neither a net-seller nor a net-buyer of real estate since 2007.

The fund is now better balanced, and since the life-cycle product is growing Sampension will add more to its property portfolio. Right now, there is a $50m (€36.4m) deal in the offing over a US multi-family fund.

"It is not yet final, but the idea is that we'll take advantage of what we think is a lack of dwellings, and we think a lot of this pent-up demand will go to multi-family homes because of the experience of owner-occupiers," he says.

Looking further afield, Larsen says Sampension is already present in some Asian property funds, and could go further in this region. "We might be interested in expanding, but pricing is an issue. That's why we're hesitating at the moment."

In common with most Danish pension funds, Sampension's property holdings on national territory are all held directly, but so too are investments in Germany and the UK.

"We also find it's convenient for us to invest alongside other pension funds," he says. "In that way we also get information which is independent of the manager."