Institutional investors should invest in both public and private real estate rather than treat them as mutually exclusive. That was one of the conclusions of a debate on the relative merits of public and private investment vehicles at Expo Real.
The panel debate, held at the Expo Real Forum, certainly had two individuals best placed to take opposing sides: Matthias Thomas, CEO of the European Association for Investors in Non-listed Real Estate Vehicles (INREV), and Philip Charls CEO of the European Public Real Estate Association (EPRA). It also included two less partisan participants – Kiran Pital, CIO of Cordea Savills, and Knut Riesmeier, founder of Riesmeier Capital and former global head of real estate for Munich RE insurance group – and was moderated by IP Real Estate editor Richard Lowe.
Challenged on the greater liquidity associated with listed, Thomas down-played the demand for liquidity. “The investors we’re talking about just don’t need it,” he said. “They know property is illiquid. Liquidity is an irrelevant issue.”
Faced with the argument that listed real estate potentially introduces volatility to investors’ portfolios, Charls pointed to a transparent listed market that was effectively “regulated by banks, analysts and markets”.
Volatility, once the stick used to beat the listed sector, has become more pervasive since the onset of the crisis, including the non-listed real estate market. The question is how investors manage it.
In response to Lowe’s suggestion that investing in REITs meant potentially bringing volatility into the portfolio when one reason for investing in real estate was to avoid it in the first place, Charls warned the audience not to underestimate the potential for volatility in non-listed investments. It’s a false debate,” he said. “There’s always volatility. It’s just that in listed the volatility is visible.”
Patel agreed. “Don’t underestimate the volatility in direct, especially leveraged direct,” he said. “As an investor you have to be aware of it and calculate the risk premium if you want to avoid having volatility on the books at the wrong point in time. If you invest in a listed vehicle, the volatility is on the books. In an unlisted vehicle, it might be smoother but the underlying is just as volatile.”
In fact, Charls argued, it might well be that the stock market acts as a “shock absorber”. He recalled a meeting at Wembley Stadium in 2009 on a day the value of the stadium fell below €1m. “But the market recapitalised itself, getting access to capital, deleveraging and paying a dividend,” he said.
The idea that listed real estate acts as a proxy for direct market – in the long term, if not the short term – has gained fairly broad acceptance. Patel described listed and non-listed as “just other forms of real estate – like derivatives or bonds”.
He said: “In both cases you’ll get the characteristics of the underlying asset coming through. Those characteristics are not dependent on the structure overlaying it.”
Investors’ desire to get at the asset, regardless of the vehicle, is an additional reason for an aversion to leverage, which has somewhat superseded old concerns such as volatility. Each of the approaches, listed and non-listed, has specific characteristics that, at one time or another, in one form or another, meet specific investor requirements. Yet even relatively sophisticated investors that are able to manage allocations to listed and non-listed in order to mitigate short-term and long-term volatility are unwilling to accept significant levels of debt.
Thomas pointed to a clear preference among investors for core and value-added styles with low exposure to leverage, and concern about style drift that could limit their control. “Fund managers used to use debt as an enhancer. Now the focus is on the asset,” he said.
“It’s an argument you hear from pension funds all the time – that they want to capture the underlying,” said Patel. “When you load leverage on top, you’re losing some of those [underlying] characteristics. A pension fund with a big fixed income portfolio could be borrowing on the one hand and lending on the other.”
The crisis has encouraged investors to rethink blending. “We’ve seen some practice in the market – and there’s potentially room for more,” suggested Lowe.
So what advantages are there to combining public and private within the same real estate portfolio? Opting for listed or non-listed does not necessarily depend on the upsides and downsides of each approach but on investors’ requirements.
It depends primarily how long investors want the exposure for, according to Riesmeier. In unfamiliar markets, a real estate investment trust (REIT) could provide immediate access, albeit with less control over the asset. In more familiar markets, investing in non-listed funds keeps them closer to the asset.
According to Patel, it allows investors to mitigate points of volatility across the duration of the investment. “Managing the volatility of different investments with different durations is one of the merits of the dual investment approach,” he said.
What about the proponents of listed and unlisted? Partisan they may still be, but they are bowing to the inevitable. Pension funds no longer see private and listed real estate as an ‘either – or’ investment decision but are instead looking to combine the two approaches, according to Charls. “I personally believe the number one strength of listed is diversification and you get that from a blended approach.”
He cited Dutch pension fund managers APG and PGGM, both of which combine public and private exposures within their real estate portfolios. But he acknowledged that some investors remain to be convinced. German insurer Allianz’s €19bn real estate subsidiary has to date avoided investing in listed. “We’re working on them,” said Charls.
Asian investors, which the panellists agreed could be approached as potential investors in debt funds to help plug the funding gap, have so far shown an overwhelming preference for direct real estate.
“The industry should work a lot harder to get people with the money, especially CIC [China Investment Corporation]. China wants money to go outside the country. We need to sell Europe to those investors.”
Yet, he acknowledged many Asia investors, notably Korean pension funds, want assets they can touch and feel safe, even if that gives them a €250m exposure in one city in one market. “There are still extremes [of exposure] but blended is the way to go,” he said.