Rockspring PIM was established in 2004 through a management buy-out of Prudential PIM from Prudential Financial. With €6.2bn assets under management and no external shareholders, Rockspring is now focused on the acquisition and active management of UK and continental European real estate investments. Richard Plummer presents the case for non-listed investments and the challenges facing the industry to Martin Hurst
What are the key challenges facing institutional investors?
Everyone claims that REITs are the answer to the illiquidity of property. Yet if one regards real estate as a lumpy asset with characteristics that differ from those of bonds and equities it is important to recognise this in practice. If one believes that real estate is an asset class distinct from bonds and equities it is helpful to preserve those characteristics.
In the US the public REIT market is large, but investing directly in ‘private' (ie, non-public) property has not gone away and many pension funds have both direct and indirect investments. The question is whether the market will price these REITs correctly.
In the US, 13-15 REITs have been taken private in recent months, which suggests private equity investors currently place a higher value on the underlying real estate assets than the public market. Part of the reason for this may be the market practice of valuing REITs solely on the basis of their cash flows without perhaps adequately reflecting the underlying quality of the assets rather than the underlying value of the assets. As a result private equity professionals are making money by disaggregating public REITs.
I see no reason why Europe should not, from time to time, witness something similar when one side of the market takes the view that the other side is pricing incorrectly, but it is rather too early to tell at this stage.
Is a REIT in the UK going to be valued at a premium or a discount depending on its strategy? I don't doubt that, during the course of an economic cycle, REITs will find themselves standing at premiums or discounts to underlying asset value which will reflect the markets' changing view and value attribution, over time, of real estate as an investment option. But I also expect that, over time, investors will pay a higher price for REITs that exhibit well-executed, management focused, more narrowly defined strategies than entities with less well defined, perhaps more diverse portfolios or investment strategies.
In the public markets, the ordinary investor has no influence on strategies and capabilities of management. The only choice the investor can make is to buy or to sell - in other words, to vote with their feet. In sharp contrast the performance of private (non-listed) property can be directly influenced by owners' (or managers') strategic, technical and asset management competencies. In short, unlike the commoditised world of publicly listed real estate, by directly owning, or having an investment in, private property shrewd investors can benefit from the pricing imperfections of the private markets and directly influence the underlying performance of the assets by the application of specific asset management practices.
What is your view of the progress institutional investors are making on investment issues?
European pension funds have modernised in terms of investment strategies and consultants have helped them to achieve this; consultants have developed considerably in terms of their insight and understanding. However, investors are increasingly requiring a larger body of information to understand the various investment options on offer.
Most investors are reasonably comfortable with leverage. And most understand that they actually need to use debt to shelter the investment income from tax when investing cross-border. US investors tend to have demonstrated a tolerance for higher debt ratios, not least because it helps them enhance returns.
European institutional investors have grown significantly in terms of their market insight over the past five years. Some countries have lagged behind because they may not have developed (or had legislation that encouraged) a long-term savings culture, but this is now changing for the better.
Plan sponsors should focus on the manager and the strategy - some focus too much on individual transactions. It is more valuable for them to look at the manager's process and strategy than what the manager is actually buying.There also needs to be a greater understanding among investors of fee structures - as it is, they often don't ask the right questions or receive the right answers.
What are your views on corporate governance?
Some investors (or their representatives) may argue that if a non-executive director has been in place for years and is doing a good job, they should be allowed to continue. Others might assert that by being in place for too long, non-executive directors become complacent, or perhaps insufficiently independent of executive management. But if investors are unhappy they can vote with their feet. I understand that some very transparent pension funds, such as CalPERS, have actually been precluded from investing in certain hedge funds because the information the pension funds have revealed on their websites makes too ‘public' the hedge fund strategies. Talk about the tail wagging the dog!
INREV has been helpful in promoting a better understanding of corporate governance issues but we also need to recognise that the imposition of excessive standardisation on funds and their managers can stifle innovation.
It's a tricky balance, especially in the private markets where the spread of investment performance generated by ‘good' managers and ‘bad' managers is significantly wider than in the public markets. Let's not homogenise managers - we need an incentive to make a difference.
Are there any European real estate markets which present particular challenges to institutional investors?
The open ended funds in Germany were victims of their structure - their unique nature (a model not replicated in most other countries) resulted from the government insisting that investment risk was transferred from the investor to the sponsoring banks. The corollary was legal constraints on the sponsoring banks in being able to sell assets at less than book cost, as well as a valuation methodology that bore little resemblance to the market - in short, assets weren't regularly marked to market - how daft is that?