Is the listed sector too volatile and correlated with equities to be included in a property portfolio, or should investors look to benefit from its liquidity and arbitrage opportunities? Richard Lowe spoke to pension funds, fund managers and advisers and found a divergence of views
Head of Non-listed European Property Investments
APG ASSET MANAGEMENT
APG Asset Management, the wholly-owned fund manager of the Dutch civil servants pension fund ABP, invests in both listed and non-listed real estate. The sectors compete with the other in terms of opportunities, so the allocation split between the two is not fixed.
Robert-Jan Foortse, head of non-listed European property investments at APG, says the attractiveness of the listed markets can have "an impact on our appetite to invest in non-listed transactions, because at some moment the listed alternative might be more attractive". The reverse, of course, is also possible.
Foortse explains that APG explores potential investments in both listed and non-listed sectors by weighing up their respective expected returns and levels of risk. But the asset manager also uses both sectors to identify the best assets available run by the best management, pursuing the optimal strategy.
"It widens your opportunities and choices," he says. "For instance, suppose an investor wants a pan-European retail exposure. You can try to find a non-listed fund but an investment in companies like Unibail-Rodamco, Corio and Klepierre might make a lot of sense."
Foortse understands the concerns that investors have with the volatility of listed real estate and correlation with equities, but he says if you have a long-term investment horizon you should be able to endure the volatility. He cites APG's investment in the aforementioned listed property companies as an example. "We've taken the view that we can live with volatility because ultimately we have exposure to a very high-quality portfolio with good management teams."
In recent years the pension fund for Belgian banking and insurance group KBC has been gradually reducing the listed proportion of its real estate portfolio from 90% to a target of 50%. This is part of a restructuring of the portfolio into a ‘real assets' allocation, including also timber and infrastructure.
Edwin Meysmans, managing director at Pensioenfonds KBC, says he has doubts about whether listed real estate really is an effective proxy for the underlying direct market and is concerned by the volatility and higher correlation with equities compared with non-listed real estate.
That said, he does believe it is still the cheapest and most accessible way of gaining exposure to the asset class. It also offers the most liquidity, but Meysmans is not sure how much of an advantage this represents, especially during times when everyone is looking for liquidity. "Even during the crisis you could sell off the listed real estate, but [only] at a horrible price," he says. "You can sell it, but the bad thing is everybody's selling, which is driving down the price."
Furthermore, listed real estate is part of the pension fund's portfolio which does not require liquidity. "I don't need this part of the portfolio to pay pensions," Meysmans says. "I don't need the liquidity of the real estate, so if there is a premium for the illiquidity - be it in private equity, infrastructure or real estate - I'll be most happy to bank on it."
Meysmans also prefers non-listed real estate for the stabilising effect it has on its portfolio, in stark contrast to listed real estate. This is particularly true of directly held property in Belgium, which has to be appraised only every five years, according to the Belgian pensions regulator.
"It doesn't move. It doesn't go up, it doesn't go down. For five years it is stable, no volatility, which is what funds are looking for - more stability in the portfolio, less volatility," he says. "The difference between listed and unlisted real estate is the time difference in the valuation."
Listed real estate does have some positive attributes over the non-listed sector, Philip Menco, CEO at De Endraagt, admits: "The big advantage of listed is it has a lot of liquidity, which is not the case with non-listed. Secondly, you have opportunities to buy listed with very large discounts and sell it at a premium. So if there is a very large discount then you may want to buy listed and keep it until the discount has been disappeared."
While this could be an interesting strategy for some investors, Menco says it is not appropriate for De Eendragt. The two reasons for this are volatility and correlations with equity markets. Menco says listed real estate is not as effective as a diversifier in the portfolio as non-listed.
"We did a lot of calculations both on the short and longer term and we maintained the conclusion that the correlation is extremely high," he says. "Of course, if you look over a 10 or 15-year period that may change, but with diversification you simply look shorter term - for say one year or two years."
And Menco is not convinced of the strategy to use listed real estate as a temporary proxy before investing in a new market. This is something that De Eendragt has done in the past, but as a result the recent correction in the listed markets the pension fund lost money.
Menco also has concerns with the amount of leverage used in the listed sector, which over the long term, he says, depresses total returns, although a similar point can be made about the non-listed funds sector. "If you take it over a longer period, then highly leveraged listed and non-listed real estate funds do considerably less than the lower leveraged ones," he says.
Senior Investment Consultant
Listed real estate does offer investors a quick and easy way of putting together a global real estate exposure, according to Douglas Crawshaw, senior investment consultant at Towers Watson. It is also difficult to achieve a global portfolio from non-listed investments alone. "If you wanted to build a truly global portfolio, then arguably, there would be a place for listed real estate securities in that portfolio," he says.
Crawshaw also says investors can use listed real estate as a temporary means of accessing particular markets. "One of the benefits is thinking about listed real estate as a place to get real estate exposure in the interim while you're waiting to have capital drawn down into other vehicles, perhaps close-ended vehicles of some nature," he says. "You could park the money, effectively, in listed real estate so that when you are given drawdown requests you can provide the capital, and it's going, effectively, from real estate to real estate." He adds there is a risk in this approach, given the equity-style volatility of the sector.
For this reason, listed real estate should not be thought of as necessarily a short-term investment, Crawshaw says. Research by Towers Watson suggests the longer you hold listed real estate the more ‘real estate-like' it becomes. Investors will also gain "a greater exposure by virtue of time to [see] actually what the individual company is doing with its real estate," he says. "You are actually benefiting from an asset management."
Crawshaw says pension fund clients vary in their use of listed real estate: some use it for its liquidity benefits, others use it for global diversification, and some for a combination of the two. But he warns it must be borne in mind that listed real estate securities are often leveraged.
"A lot of our clients either have, or have been, looking at listed real estate securities," he says. "They don't suit everybody. But they are there, and if you wanted to get global diversification in a relatively cheap way, from a management and an investment manager perspective, they're able to provide that."
PRAMERICA REAL ESTATE INVESTORS
Pension funds should invest in both listed and non-listed sectors, according to Marc Halle, managing director at Pramerica Real Estate Investors. "Real estate securities have shown themselves to be a proxy for direct real estate over the long term. There are several benefits and there's also some deficiency," he says.
The most uncomfortable deficiency is the volatility, Halle admits. "It is difficult for some pension funds to watch the value of the real estate go up and down on a daily basis, and some of the pension funds don't want to mark their portfolios to market on a daily basis," he says. "Many pension funds like investing in direct real estate because it's measured quarterly or semi-annually. However, there is still volatility in the pricing that doesn't get captured due to the appraisal-based methodology valuing real estate assets.
"On the other hand, there's too much volatility in securities because the capital markets are manic depressive. We overdo it on the way up, we overdo it on the way down and there is a capital markets influence. However, over the long term, when you look at real estate securities, it delivers returns very similar to real estate, and it's a very quick way to access the markets."
Halle says it is therefore not an "either-or proposition", and both sectors "offer a compelling investment profile" today. "We still think there are good returns to be had from public securities and we think that there are some very good returns to be had from the private real estate market."
But listed real estate should also be considered as an access to markets and market segments that may be difficult through non-listed routes. This could include markets in Asia where it is hard to invest directly or even in markets closer to home when competition on the ground is high.
"In North America for instance, and parts of Europe, it's very difficult to buy core to core-plus real estate. It's just not available on the market, but you can go to the stock market and buy a piece of real estate, you know, through an equity share today," Halle says.
Director of Balanced Funds
LEGAL & GENERAL PROPERTY
Legal & General Property (LGP) invests in real estate investment trusts (REITs), property derivatives and cash, alongside direct real estate in some of its funds - although the latter will always make up the largest part. Mike Barrie, director of balanced funds at LGP, says investors can have an advantage if they have the option to invest in "all four quadrants" of the real estate market.
LGP's institutional UK Property Trust, for example, recently sold out of most of its REIT holdings, so that, at the end of June, the fund has 1% of its capital in listed real estate. "We'd like to see a few more of the funds that we operate have the capacity to hold all four parts of the quadrant, because that gives them a definite advantage in terms of how they perform and also how they respond to changing market conditions," Barrie says.
The attraction of listed real estate is partly its liquidity - so it can perform as part of a liquid pot of assets alongside cash and derivatives - but also its relative value. Any one of unquoted real estate vehicles, property derivatives, quoted real estate stocks and direct property can "look better value at any given moment".
He adds: "Strong asset management and strong stock selection in the direct market is going to be the key factor, but I don't think you want to rule out other options."
"If you look over the longer time, maybe not unsurprisingly, the returns from REITs do have a reasonably good correlation with direct real estate. It's just that you do get in the short term some volatility around the pricing," he says.
"I certainly wouldn't suggest that a 100% REIT portfolio will operate in the same way as a 100% direct portfolio, although if you do take it over a three- to five-year time horizon then similarities do grow considerably, in terms of the longer term returns you can expect."