An increase in risk aversion among institutional investors and a return to core strategies are evident from INREV's latest Investment Intentions Survey. Lonneke Löwik reports
Institutional investors are signalling a return to the fundamentals of real estate investment by opting for core funds, results from the latest INREV study have revealed.
The results of INREV Investment Intentions 2010 show that close to 70% of investors now prefer core style funds compared to 38% in 2009. If compared with the 2008 results the difference is even greater. At that time only 5% of the investors preferred core over the other two styles. This shift towards core has been almost completely at the expense of the opportunity fund style, which fell to 3% from 37%. These results are mirrored by the fund managers' responses with almost 60% of the fund managers preferring a core style.
This shift down the risk spectrum shows that investors are focused on the benefits that real estate can offer, such as diversification and income generation, which can be found at the lower risk/return end of the scale with core funds. When this shift started in 2009 it was a reaction to the financial downturn, but the continued trend suggests that investors are revising their expectations of the role of non-listed property funds.
These funds grew as many institutional investors moved in late in the cycle in 2005-07 when the funds were using high levels of leverage. Lessons learnt from these times are likely to be leading investors back to the basics of real estate investing.
In contrast, fund of funds managers have increased their appetite for risk with 43% now preferring opportunity funds, compared to 23% last year. This partly indicates that fund of funds managers are looking to capitalise on opportunities in the current market but also reflects their general preference for higher risk/return strategies. Their strong preference for value added investments in 2009 (54%), dropped by 40 percentage points over the year to only 14%.
At 49%, close to half of the investors plan to increase their allocations to non-listed real estate funds over the next two years. This remains the majority position but is the second year that this figure has declined. In 2009, 63% of investors intended to increase allocations which was already down from 85% in 2008. However, the shift is mainly in favour of ‘no change' rather than a decrease.
Compared to last year, investors are more inclined to increase allocations to joint ventures and direct real estate. This indicates they are seeking vehicles that give them more discretion in the management of their investments. These investments often require significant capital and resources, which restricts these approaches to a limited number of larger investors.
Access to expert management continues to be the main reason to invest in non-listed property funds from all three respondent groups. Fund of funds managers and fund managers also rate highly the ability to take advantage of market conditions. However, investors are less concerned about this, reflecting their more conservative stance. Enhanced returns, the second most important reason for investments in non-listed real estate funds last year, has lost its prominent place and dropped down to fourth place.
Concern over alignment of interests was selected by almost 70% of investors as the main obstacle to investment in non-listed property funds. This overtakes both market conditions and the lack of transparency and market information. There were also notable rises in concerns from investors over the lack of liquidity and the availability of product. The ability to raise capital is seen by all respondent groups as the main obstacle facing fund managers this year.
Major obstacles for fund managers are the ability to market and close a fund, and to secure financing. Only 20% of the fund managers see managing their debt exposure as a challenge, suggesting that either they no longer have debt issues or are in full control of their debt exposure.
Investors and fund of funds managers by contrast show concern about the ability of fund managers to manage their existing debt exposure and to raise new finance. The bankers interviewed by INREV underline this concern. They predict a lack of supply of debt to meet the combined demand from new and existing borrowers. When issuing loans, bankers are taking a more conservative stance, with maximum LTVs of 65% and a focus on income-producing properties. They have little or no appetite for secondary, value added or opportunistic investments. Some bankers are taking the opportunity to build new relationships; others focus on existing relationships. But the experience, track records and execution capabilities of the borrowers are the main criteria for all.
Like bankers, investors and fund managers now see a fund manager's staff and company track record as the most important factor for fund selection. This overtakes a manager's local presence, which has been the most important criterion since 2007 and is a reflection of investors' concerns over the stability of fund managers. Fund of funds managers regard a fund's target location as the main criterion for fund selection, which reflects their focus on taking full advantage of the current market opportunities.
The most significant change in preferences in terms of fund type has been around investor involvement and investor pool size. Almost 80% of investors now prefer a high level of investor involvement, and a large proportion favour a smaller pool of co-investors. This is markedly different from findings in 2009, when preferences for a small or large pool of investors were equally divided.
It has also become much more important to invest with culturally similar investors: they prefer to speak the ‘same language', and have the same goals as their fellow investors. Alignment of interest between investors has become as important as alignment of interest between investor and fund manager.
UK offices are the preferred country/sector choice of for investors and fund managers, followed by French offices. Fund of funds managers favour the French office market and the UK retail over the UK offices market. Overall the UK features in four of the top ten, a trend which continues from 2009 with interest growing in this market, the first to experience the downturn. Eastern and Central Europe fell from the top 10 this year, as most investors favour the more core European markets. This is another reflection of an increasingly risk averse approach. Likewise, most bankers stated that they would be concentrating on the established, mature and more liquid markets of Western Europe.
This year's report also includes a special focus on the industry's approach to sustainability, which is a topic of growing importance. The study shows that sustainable factors have found their way into investment and business policies of investors and fund managers. Of the three sustainable factors - environment, social and governance - governance is the most important and most applied. Nonetheless there is still a lack of real ESG targets. Investments made towards purely sustainable non-listed property funds are still very limited. And although interest in sustainable investments in 2010 is significantly higher than last year, still the majority of respondents have no concrete plans to implement this type of investment.
Today's challenging market might be to blame: the sustainable movement was gaining considerable momentum before the downturn. But although many investors and fund managers have sustainable factors incorporated into their policies, the lack of real ESG targets is not helping either.
This year's sixth annual INREV Investment Intentions Survey provides a guide to the expected trends for 2010 among investors, fund of funds managers, fund managers and, for the first time, bankers active in the non-listed real estate funds industry. The survey attracted 119 respondents, which comprised 35 investors, 14 fund of funds managers and 70 fund managers. Of the total, 105 were INREV members, representing a 40% response rate.
Lonneke Löwik is director of research and market information at INREV