The switch from defined benefit to defined contribution is a huge opportunity for listed property and REITs, but this might be squandered if the industry and the European Commission do not get their acts together, as Gareth Lewis reports
The growth of defined contribution (DC) schemes and the disappearance of defined benefits (DB) schemes is widely viewed as a certainty. On the one hand, this could represent an excellent opportunity for the European listed property sector to deliver its potential - a defining moment for the growth of the sector and its emergence as a mature market and a core asset class.
On the other hand, it could also give rise to a huge missed opportunity for the sector and more importantly, the ability for a European pension fund framework to efficiently meet the needs of Europe's ageing population.
First the optimistic angle. We can expect DC pension schemes with strategies including default investment options for major asset classes to be a major growth area in Europe. Listed property companies including REITs could be in a fantastic position to attract capital as a result of these default investment allocations for passive investors - provided that real estate is rightly viewed as a separate asset class.
A look at developments that have occurred in the US show that real estate is generally viewed as a distinct asset class within these plans and, importantly, REITs are viewed as part of that real estate allocation. Because the DC framework allocates more control with regard to investment decisions to the fund manager and the individual pension plan holders, liquidity is an important factor when considering allocations compared with DB schemes. This puts REITs in a potentially strong position as a preferred investment vehicle compared with less liquid forms of direct and indirect investment in property.
Another way of looking at this is much less positive, and raises an important point related to the European listed property sector and its ability to contribute to a successful European pension framework. This concern stems from the fragmented and uncoordinated nature of the European listed property sector.
Given this state of affairs, it is hard to see how a coherent approach to pension fund investment into real estate, which aligns with the specific requirements of the DC schemes (including target date funds, etc) can be achieved in the same way that it has in such countries as the US and Australia.
REITs in the US (after 50 years of history) are a significant and widely understood investment product and it is clear that REITs, as a liquid form of real estate, are well suited to the requirements of DC schemes. In contrast, the European listed property sector is fragmented, hard to understand and relatively small itself compared with other regions.
This is, of course, understandable given that the EU has 27 member states, each with its own tax legislation - and is one of the reasons why the European listed sector is so small compared with other major regions. Many European states don't even have REIT legislation, and when they do they tend to be structured differently and have different names (REITs, G-REITs, SICAFIS, FBIs, SIICs to name a few!).
We at EPRA believe that the European Commission urgently needs to provide leadership by both prioritising the development of a coherent European listed sector, and at the same time by promoting the ‘best practice' examples from the more developed DC markets - such as the US and Australia, when developing the European pension fund framework.
We can only regret that in reaction to the financial crisis, the EC seems to have focused most if not all of its efforts on producing more legislation, and with an urgency that has inevitably hampered its ability to respect its pledge for ‘better regulation'. We are eager to see and ready to support and contribute to a more positive approach of developing best practice from the EU executive.
Looking at the ability of European REITs to survive the financial crisis intact (in contrast with the fate of other vehicles, such as the German open ended funds), it is clear that a larger listed property sector in Europe would also go a long way to achieving the EU's objective of increasing the long-term stability of the European markets.
• Positive EU leadership in developing an EU listed property sector worthy of any developed global market - both in terms of size and structure. Most effectively achieved through;
- Encouraging the emergence and development of the REIT regimes(the most efficient form of listed property market) in member states;
- Improving the onerous equity raising rules in Europe to bring them into line with global best practice;
- Reducing taxation barriers to cross border investment into and within the EU, and achieve something akin to a pan-European REIT framework - by acknowledging each other's REIT regimes through ‘mutual recognition';
• Recognition that REITs are real estate investment and should comprise a portion of the overall real estate allocation;
• Recognition that real estate investment should comprise 5-15% of the overall portfolio allocation.
For the European REIT sector, even a small improvement in this regard could have a very positive influence on capital flows into the sector. It would be a major step in creating a genuinely relevant European listed property sector, prone to attract institutional and other global investors, advancing the stability and transparency of the property investment markets, and improving the efficiency of the European built environment.
Gareth Lewis is director of finance, EPRA