Returns are steady rather than stellar. But with characteristics that allow for liability-matching, inflation-hedging and a low-risk profile, it is not hard to see why pension funds might want to buy into ground rent funds.
UK pension schemes have committed close to £100m (€163m) to the UK Ground Lease Fund since Pramerica took over its management from UBS Global Asset Management. As a result, the fund has attracted a total of £225m from investors. Aviva Investors is likewise targeting underfunded UK pension funds - the Aviva staff pension fund being a seed investor - for its ground rent fund, launched a few weeks earlier.
Ground leases offer secure investments: they are normally more than 75 years in length (and often more than 100 years) and backed by the underlying collateral of the land and buildings. Despite a well-defined market, if you look at some of the other attributes associated with ground rent investments, you might start to wonder why a fund manager would want to set up a dedicated vehicle. There may be a steady volume of buyers, for example, but where are the sellers?
As David Skinner, investment strategy and research director at Aviva Investors, points out, it is an "extremely limited" pool.
Sellers are not, in fact, absent from the market. The Crown Estate is known to have sold one. Spokesman Andy Payne did not confirm the sale but he said, assuming it had taken place, the rationale would have been to raise capital with a view to rebalancing the portfolio away from central London towards regional retail.
Distress might be another reason. "We've managed to find ground rents in sufficient quantities to meet the demand," says Pramerica UK fund management director Paul Dennis-Jones. "As a property investor, you have to go and find them. People don't want to sell them. Why would they? They only do it if they need cash."
The Aviva fund has pre-empted the supply problem by doing deals with house builders via its partner in the fund, Dorchester Ground Rent Management.
"We're actually looking at newly created ground rent," says Jo Silmon-Clyde, head of retirement LDI at Aviva Investors. "Modern ones have more attractive ground rents, including a seven-year review linked to RPI. The old ones didn't have that, although they double every 25 years."
Even were it not for these developer deals, Skinner says, there are sufficient ground rents owned by private investors or leveraged investors for him not to be especially worried about supply. "There's a lot of existing stock, though we have enough supply that we haven't had to look at it yet," he says. "But, yes, it takes time to piece it together."
Concern over supply is not the only caveat. There is certainly an opportunistic element to both funds, since they are both benefiting from investors looking beyond traditional fixed income assets whose yields are miserly. In fact, it is because bond yields are so meagre that ground rent yields look so appealing. Instead of 0.5% on a government bond, you can make 4-4.5% investing in a ground rent fund.
These are not alpha-seeking investments. To make a significant return, there would have to be a default, and that almost never happens. "As an investor, we'd like people to default but it would be absurd to," says Silmon-Clyde.
And Dennis-Jones says: "What makes them so secure is that you invest £15m, but the ground rent only takes a tiny bit of the capital value. If there's a default, you rank ahead of the bank and everyone else. So if you don't get paid, you get £100m back on your £15m. But the reality is that people always pay their ground rent."
This is not a property investment then? Both fund managers agree that capital for the fund is being reallocated from fixed income. "It is an alternative to get cash flow - an alternative to corporate bonds, but with a property structure," says Silmon-Clyde.
The opportunity for geographic diversification is negligible: this is a UK market-specific investment. But it has other advantages. "The reason this fund works is because there is a premium attached to liquidity," says Silmon-Clyde. "When liquidity wasn't an issue, the premium was low. Now liquidity has dried up, an investor prepared to supply it for long periods can take advantage of the liquidity premium."
He adds: "What's specific is not the ground rent but the underlying made available for pension funds. It's a way of providing investors with a single exposure to a liquidity premium."