What role should listed real estate play in institutional portfolios? Rachel Fixsen asks six investors and advisers

Stephen Tross
Plans to expand allocation to REITs
Capital reserve requirements are lower due to vehicles' liquidity

Bouwinvest, which manages the real estate assets of the Dutch construction workers' pension fund, spent last year rethinking its allocation to real estate as part of its strategic plan for 2012-14, and decided to expand its allocation to REITs.

"Part of the international mandate of Bouwinvest is to invest in real estate securities; REITs are currently only a small portion of the investments," says Stephen Tross, director of international investments at Bouwinvest. "We are going to increase the allocation for a variety of reasons. First of all, holding REITs increases the liquidity of our portfolio and, secondly, the capital reserve requirements put forward by the central bank are lower than for unlisted real estate, because of the greater liquidity.

"Thirdly, we use listed real estate because there are certain propositions or areas where the best real estate is held by listed REITs." Tross says these vehicles then become the only or preferred way to gain the desired exposure. For example, most regional shopping malls in the US are held by REITs, he says.

Bouwinvest has €100m invested in REITs. "We are now increasing it to €300m and we'll see where we go from there," Tross says.

Because of the higher volatility, REITs still only make up a relatively small portion of Bouwinvest's overall €6bn property investments for the construction workers' fund. Just under €2bn is invested internationally and €4bn is within the Netherlands.

While some argue that REITs are too similar to equities to be useful in a real estate portfolio, Tross says it depends on how an investor uses the vehicles.

"We are a long-term investor and that's also how we invest in listed real estate. We have a buy-and-hold strategy," he says. "We view REITs as part of our tactical asset allocation. If we view certain property markets and sectors as attractive based on the fundamentals, we will look at both listed and unlisted opportunities for getting exposure.

"If there is similar quality real estate in a listed vehicle, which trades at a discount to NAV, then that might be an advantage to an unlisted vehicle when you have to go in at NAV," Tross says. That discount has to be analysed, of course, he adds.

Simon Robson Brown
CBRE Clarion Securities
Growing DC flows will increase demand for REITs
Beta is a short-term phenomenon with listed real estate

Pension funds in Europe are poised to invest significantly more in listed real estate and REITs over the coming years, according to Simon Robson Brown, senior vice president at CBRE Clarion Securities.

"The GFC has focused investors' minds on liquidity and diversification," he says. "Real estate is often bought for the strong cash flows it generates and the diversification it brings to a portfolio.

"By adding listed to the mix of strategies used, they will increase liquidity, and also the diversification they can achieve, as it is a very cost-efficient and transparent way of gaining the exposure."

On top of this, as defined contribution (DC) pension flows continue to grow, it will become more important to obtain regular pricing points, and for smaller investors to be able to access broad real estate exposure. Listed real estate is ideally suited for this, Robson Brown says.

Since listed real estate is in an equity wrapper, it does carry a lot of market movement, or beta, in the price. But he points out that this is a short-term phenomenon.

"Underlying this is the fact that cash flow is generated from managing, operating or developing real estate investments, so over the medium to long term the characteristics of real estate investment will emerge," he says.

It is important to understand that listed real estate companies have strong management teams who take decisions independently of the investors in their company. "This means they can use leverage as well as other techniques to develop the business," Robson Brown says. "When an institution buys a direct property it can dictate the leverage, et cetera, in the property, which does distinguish the two types of investment."

Lasting success with listed real estate depends on having thorough knowledge of the investments and their environment, he says. "To be a consistently strong performer we believe you have to have real insight to many local markets, the experience to understand how different types of real estate will react to different macroeconomic environments and a great knowledge of the underlying management teams and balance sheets they run."

Peter Olsson
AP Pension
Direct investments are best way to gain RE exposure
Fund may consider REITs after merger with FSP

Denmark's AP Pension is a significant investor in property, like many of its domestic counterparts. At the end of last year, the customer-owned commercial pension provider had 11.6% of its €7.4bn in assets invested in land and buildings.

The allocation is invested in direct property in Denmark, and indirectly in unlisted property funds outside its home market. As things stand, REITs play no role for AP Pension.

"We're not using them at the moment," says Peter Olsson, head of property investments. "Of course we have considered it, just as we consider all business opportunities."

The main reason why the Danish fund is staying out of REITs and other listed property investments for now, has to do with resources, he explains. "It always takes time to look into a new investment area, and we have limited time," he says.

AP Pension is currently involved in a merger with FSP, the Danish labour-market pension fund for financial sector employees. A merger between any two organisations takes time and uses resources in the run up to its completion, and this is the case for AP Pension right now.

But Olsson also has some doubts about the suitability of listed real estate vehicles for AP Pension's property portfolio. "They are more correlated to equities," he says. "If you want exposure to real estate, then the best way to get that is through direct property of unlisted funds."

However, when time does allow, Olsson expects AP Pension to examine the possibility of adding listed property to the portfolio. The vehicles certainly have benefits, he says, notably the flexibility they can offer within a portfolio that is traditionally rigid and illiquid.

"It is something that could be appealing to many investors," he says. "Of course they are interesting, too, from a liquidity perspective. The liquidity in direct real estate is one of its big disadvantages, and that's absolutely something that means listed real estate could be attractive."

Andrew Jackson
Standard Life Investments
Resurgence of interest coming through from institutions
Tax is an important factor in US investments

Standard Life Investments has four property funds that invest in REITs, including three global REIT funds and one hybrid fund investing in direct property as well as listed property funds.

US REITs account for around half of the investment universe for the global REITs funds, says Andrew Jackson, head of wholesale and listed real estate funds. The rest consists of REITs from Hong Kong, Singapore, Australia, continental Europe and the UK, as well as Canada.

Although the team at Standard Life Investments is fairly neutral on the REITs market at the moment, Jackson notes a resurgence of interest coming through from institutional investors. "We've seen a number of mandates coming out in the last six months," he says.

In order to understand why this might be happening, Jackson explains that institutions tend to view REITs differently. "For some pension funds, for example, listed real estate is part of their wider equity portfolio," he says. "These are larger institutions, and they're looking for exposure to specialist areas. Others may see it as part of their alternatives and property portfolio, and they're seeing it as adding liquidity."

Although some property-seeking investors avoid REITs because their market movements are too closely aligned to equities, Jackson says this argument only holds for short-term investment. "Our own analysis shows that up to 18 months there is a stronger correlation with equities, but beyond that REITs move more in line with property," he says.

REITs simply offer more flexibility, he argues. "You can get a lot of exposure relatively quickly and when you want to trim that exposure, you can do so quickly too. You are not necessarily having to sit on cash, so you are fully invested all the time."

Acquisition costs for UK direct property are 5-6%, with another 2% to exit, while the cost of buying and selling REITs only adds up to 1% in total, he points out.

Taxation is always a consideration in international investment, and using REITs to gain exposure can make sense from this point of view in the US. "For foreign investors, the taxation can be really quite high for direct investments in the US," says Jackson. "REITs can be a tax-efficient way of investing."

Arjan Vermaire
Pensioenfonds Vervoer
Correlation between REITs and equities too high
Direct property fits in well with overall portfolio

Pensioenfonds Vervoer, the Dutch transport industry pension fund, has allocated 3% of its €13bn of assets to real estate. However, none of this is currently invested via listed vehicles, such as REITs, nor does the pension fund have any plans to use them.

Arjan Vermaire, strategist at Pensioenfonds Vervoer, agrees that there are various problems associated with listed property vehicles as far as institutional investment in real estate is concerned.

For one thing, the market behaviour of REITs is too similar to equities, he believes. "Long-term correlation with equities in studies is typically 0.5 to 0.7, with short-term lagged correlations sometimes higher than that," Vermaire says. But he adds that in order to avoid over-diversification, it is prudent to use a higher correlation in long-term ALM studies.

That some REITs have a small number of investors owning large stakes can sometimes be an issue for potential investors. "From a liquidity standpoint this matters," he says.
Blending listed and non-listed real estate investment, as some institutional investors do, will create lower beta due to differences in IFRS treatment of valuation policies, Vermaire says. "However comparability will go out of the window," he notes.

"Listed is always a bucketing problem," he says. "Is it real-estate or equities? If you need the liquidity and want to invest in real estate it might be an idea. If you don't need the liquidity you are better off with diversifying absolute-return characteristics amongst which there is an inflation component as well."

This is the case in real estate investments where the level of leverage is on the low side, Vermaire says. Otherwise, he adds, the indirect returns end up pretty much erasing this inflation-tracking effect.

"We do invest in non-listed real estate and are still thinking about our strategy," he says. There are many factors to be considered, he says. For example, offices seem to be very highly correlated across countries in prime locations. "You wonder whether the volatility isn't too big for the returns."

In the end, bricks and mortar fits in well with the overall portfolio because of the way it spreads risk. "We like the stable cash flow, direct return characteristics in order to have a diversifying effect towards, for example, equities, bonds and so on," says Vermaire.

Richard Cooper
Aon Hewitt
REITs could be alternative to geared global property funds
Listed vehicles potentially easier to research

REITs and property trusts are held by some UK pension funds within their property allocation, but generally as a satellite rather than a core exposure to the asset class, says Richard Cooper, property specialist at consultancy Aon Hewitt.

"When they are used, it is usually as a short-term replacement for direct property or to add liquidity, but they are certainly not used as a key pillar of the property allocation," he says.

Although it is not clear whether pension funds in general are likely to increase or decrease their overall REITs investment from this point on, Cooper suggests some pension institutions may consider using REITs in place of geared property funds for their non-UK exposure. "This could happen in cases where pension funds have exposure to specialist funds - for instance, in continental Europe," he says. "Those funds generally have relatively high wlevels of gearing, but they're also quite illiquid."

Pension funds in such a position could be drawn to the additional liquidity offered by REITs. There are other potential benefits for property investors in buying into the listed securities, he adds.

There is certainly some positive correlation between the capital growth on the IPD UK index and UK REITs, he observes. "If you appreciate that the listed market pricing leads the direct property market by, say, six months, then you could look to get long-term property market beta from such securities. However, an investor would have to accept more volatility, and that there won't necessarily be a strong short-term correlation."

But he notes that listed property won't perform in lock-step with bricks and mortar investments. "Part of the reason direct property gives you the style of return it does, is because it's a tangible asset. It's valued and not priced on a continuously traded stock market." Valuers have to support their valuations based on recent transactional evidence that is available, and this, Cooper says, is very different from the way a security is priced. Added to this, the fact that REITs have gearing also makes the return differ from that on direct property investments.

However, as market-listed securities, there is more publicly available information on REITs than on their unlisted counterparts, and this factor makes them potentially easier for investors to research.