Two years into the job, Allianz Real Estate CEO Olivier Piani is still on track to achieve his real estate allocation target in spite of a sticky market. He talks to Martin Hurst about strategic allocation objectives, Solvency II, lending and third-party management
Since Olivier Piani joined Allianz Real Estate as CEO in September 2008 one of his main tasks has been to build a real estate allocation of 6%, double the level when he took over, as part of the overall strategy of Allianz to create a more diversified investment portfolio. How are things going? "We have to buy €10bn of assets to get there; so far we have bought a billion and a half," he says. "This just shows how difficult it is to execute our strategy because of the illiquidity of the market. This was at its most challenging in the first half of 2009; it eased in the second half and further in the first half of 2010. We expect to reach our 6% target in three years."
Another key objective is to reweight the portfolio. Two years ago the portfolio was 95% allocated to Europe and mainly to residential. "We started from a position typical of European insurance companies with a lot of residential assets and hardly any retail," Piani explains. "Our aim is to create a more diversified real estate portfolio and one element of the strategy will be an allocation to retail of 20-25%. Retail in Europe is not traded often so this will be challenging; we will have to work with what there is. By contrast the office market is the most liquid in the world so this is a typical asset for a long-term investor like us."
In terms of geography, Allianz Real Estate aims to quadruple its ex-Europe allocation to 20%. Compared with other large European investors the 80% allocation to Europe is still high. "Allianz as an economic entity is a major insurance company in Germany in France, Italy, Spain, Belgium and Switzerland," Pianis says. "This accounts for more than 80% of the Allianz insurance business, so this is a liability matching of sorts."
Allianz does not have any significant UK insurance business so does not need to be invested in UK real estate on that account. "So even though the UK market is the biggest, most liquid and most transparent market, any investment there would be purely opportunistic," Piani says. "We have some assets there but after the UK market rebounded following the downturn we consider it a little expensive today, but we shall be monitoring the situation. Furthermore we have to consider the additional cost of currency hedging."
Allianz carries out all investment in Europe in-house with the exception of logistics where the assets are small and spread out. It invests in funds in Asia and the West Coast of the US where it has limited local expertise.
The impact of Solvency II on real estate investing by insurance companies has been widely debated. For the insurance companies themselves, which invest mainly in bonds, there is another, greater concern. "The issue today for insurance companies is not so much Solvency II as far as real estate investing is concerned but the fact that interest rates are so low," Piani says. "When you renew a bond that comes to maturity you get 2.5%, which is too low to finance adequately the business of insurance companies. By contrast real estate yields 5-6%. It is not so much a question of whether we have enough capital to invest in real estate but that we need to find an alternative asset allocation that increases the overall yield of the portfolio."
The capital charges imposed on real estate by Solvency II have been criticised, but Piani doesn't see a problem. "The Solvency II discussion leads us to the view that real estate should be held with a 30% equity portion and 70% debt," he says. "If I were to start a business in real estate tomorrow where I would be holding real estate assets over time I think I would have at least 30% equity if not more, so the proposal of the regulator does not seem insane."
Most of the criticism has come from the real estate industry, but for Allianz this is a relatively small part of the overall business. "Real estate is about 4% of the balance sheet moving to 6%, so this is not a major issue for Allianz," Piani explains. "Even if they double the capital charge for real estate it would not be a major issue. The major issue for Allianz is how it accounts for the 80% we have in bonds or the 10% in equities. That said the will of Allianz to invest in real estate has grown as interest rates have stayed as they are and if we were able to find the assets I think there would be a case to allocate more than 6% to the asset class."
Further growth opportunities may arise from the de-leveraging of the banks as well as the impact on banks of Basel III which offer insurance companies and other institutional investors an opportunity in real estate financing. Piani explains that Allianz is no stranger to real estate lending. "We own a lot of Pfandbrief - some €10bn. Furthermore, in the US we have an insurance business with a $5bn loan book. US insurance companies have always been and continue to be major lenders to real estate. The opportunity has never existed in Europe because the margins for lending were so low. Today the whole banking sector is reassessing its position in Europe; the role they should play is an interesting question. I think there should be a larger role for institutional investors in lending provided the banks don't drive down margins."
Lending is over and above the target real estate allocation but it is the responsibility of Allianz Real Estate to manage and grow the business.
Some have asked whether the lending market is ready to welcome non-banking institutions. Piani believes it is. "If we consider those who own real estate and use leverage - listed real estate companies and funds - it would not be difficult to approach them as potential clients," he says. "Especially given that there is a limited number of borrowers an insurance company would want to have I am sure this is feasible. All you need to do is decide if this is your strategy, and confirm that sufficient margins are available."
Banking relationships are also influenced by the ability of the lender to provide a range of services to its client - M&A, capital raising and other investment banking functions. Piani stresses this is not an objective. "We would never enter the investment banking space; it is outside our core area of expertise."
As a potential growth engine, third party management must be a compelling option. Is this something Allianz will consider in the future? "We will fully reassess position once we have reached our target 6% real estate allocation," Piani says. "The case in favour is to continue to grow the business and create an external fee income as opposed to a purely internal fee income. The downside is that it would create conflicts of interest immediately.