Investor Forum: Making markets mainstream
With keen pricing in core markets, investors are looking at opportunities in alternatives. Rachel Fixsen talks to six investors and managers
AXA Real Estate
• Sees alternatives as growth area for own and third-party capital
• Slice of GDP spent on what happens postretirement to increase
Alternative real estate is an increasingly key investment segment for AXA Real Estate, says Riccardo Dallolio, head of alternatives and special situations. “We decided to strengthen the team and create a strong focus within AXA in this sector as we think it’s an important area of growth both for our own capital and the third-party capital we manage,” he says.
The manager currently has around €3bn invested in alternatives such as hotels, healthcare, data centres and automotive real estate. “We see value in the market for this kind of investment at the moment,” he says. “There is an element of opportunity, and that can be unlocked by specific expertise.”
In these sectors, the macro dynamics tend to be different to those in traditional property asset classes, he explains, with alternative sectors being driven by forces such as demographics for senior care and healthcare, and the outsourcing of IT for the data centre business.
“The amount of GDP spent on what happens after retirement will increase, and therefore that’s an area of growth in the economy one could invest in, in finding the right solutions.” More companies are deciding to put their growing volume of data storage in the hands of professional managers who have secure premises with good power supplies, he says.
Dallolio sees a trend towards the institutionalisation of alternative real estate assets. “At the moment, the asset class is not a prime target for traditional institutional investors — it is on the periphery,” he says. There are specific risks with alternative property investments, he acknowledges, but says that these are priced into the deals the manager undertakes. Getting to know a type of alternative before making an investment is vital, he says.
“We want to understand the underlying business and how the real estate works with the business of the tenant. “Obviously these assets do have lower liquidity than other sectors, but we think eventually this liquidity gap will close,” he predicts.
• Active in logistics, healthcare and residential sectors
• Very specific approach needed for logistics; looking at retail trends, international trade
As well as managing exposure to the German healthcare and residential sectors, Deutsche Asset & Wealth Management (DeAWM) is active in logistics across Europe, both in the funds it runs as well as mandates, says Simon Durkin, head of research and strategy for DeAWM’s alternatives and real assets business. “The industry can tend to use the term alternative in an extremely wide context but we wouldn’t usually include, for example, logistics in the sector,” he says.
But as an often-perceived alternative investment, Durkin says he is very positive about the prospects for European logistics. It is important to take a very specific approach to the sector, he says, because future performance will be driven by changing retail trends and international trade.
“In 2013, demand was driven by supply-chain reconfiguration in support of e-commerce and multichannel retailing, with more occupiers beginning to focus on being close to customer markets in order to satisfy same-day delivery,” Durkin observes. “The supply pipeline, which is back to its highest level since 2008, gives some indication of the market returning to strength. Unlike in the previous cycle, however, construction activity will be driven by built-to-suit and owner-occupied properties.”
Looking ahead, there are always risks when extrapolating trends to forecast markets – people should not forget that these risks are both upside and downside. “What we are seeing is that the balance of risks generally in Europe seems to be shifting.”
Real estate alternatives often carry higher liquidity and operational risks than more mainstream sectors. “Liquidity is a key determinant of pricing and intuitively the more alternative a sector is, the less liquidity that market might exhibit,” Durkin observes. “It is important to make decisions based on a solid and comprehensive understanding of the risk-return profile.”
As far as operational risks are concerned, he says the best way to mitigate these is to work with the best possible partners who really understand the supply and-demand dynamics in a given sector — and can show they have a clear record of operating successfully in a particular market.
• Growing exposure to student housing, car parks and nursing homes
• Covenants within alternatives now seen as stronger
As well as investing in more traditional real estate assets, Aviva Investors also has exposure to alternatives such as student accommodation, car parks and nursing homes. Investment in these sectors is generally increasing, says John Gellatly, the company’s head of European real estate multi-manager. “If I’m in a market with a relative return mandate, and there’s another category then we will target those and generally be overweight to those sectors,” he says.
Covenants within alternative real estate investments are now better than before, he notes, and cash flows longer. “Pricing is attractive but the pricing has firmed a lot over the last few years, so it is not as popular as it was,” he says.
Student accommodation and nursing homes in particular are getting the critical mass and awareness in the UK, and there are a number of players in the market. “Retail warehouses, for example — when these came out 25 years go, they were out-of-town sheds, but now they have fundamentally evolved and they’re a part of everyone’s portfolios.”
It is the job of a multi-manager to think of the big strategic themes coming through, he says. “Because we’ve got to think about what’s going to drive our performance through our hold periods over the medium term,” Gellatly says. “But we need to make sure the environment is right for someone to buy us out at exit. In many countries, we’ve been doing a lot of medical investing,” he says. “The question is, where on the age spectrum do you want to sit, or do you want to invest across it?” The sector includes primary care, hospitals, retirement villages, leading on to nursing homes and more serious care homes, he says. “We’ve put money into designing dementia care homes, because we know dementia will be a massive problem over the next few years,” he says. Gellatly says Aviva Investors’ multi-manager mandates are increasingly allowing it to access property via unlisted funds or directly through the listed market, joint ventures or small club investments. “Our access route is becoming less important – it’s the way the attributes stack up,” he says.
Strathclyde Pension Fund
• Alternative investments include cinemas, student housing, gyms
• Takes bottom-up approach to investment
Although the Strathclyde Pension Fund holds a range of real estate assets that would generally be seen as alternative, it does not have a specific allocation to alternatives or aim to gain exposure to alternative sectors. “Within the UK, the fund doesn’t directly target alternative property sectors,” explains Richard McIndoe, head of pensions at the £13.4bn (€16.8bn) Scottish local authority pension fund.
“That said, we are still happy to acquire good assets in those sectors – it just happens to be a bottom-up rather than top-down approach,” he says. “While that means the UK portfolio is mostly in traditional assets like offices, retail and industrial, we also directly own a number of properties that we would probably consider as alternatives.”
Examples of the fund’s alternative assets are cinemas, a student accommodation block and a Virgin Active gym. In addition, the pension fund has recently concluded the purchase of a hotel. “Outside the UK, our approach is less direct, through private real estate funds, which get us very diversified exposure,” he says. “That includes sectoral funds such as hotels, student accommodation, medical facilities.”
Included within these non-UK investments are some other unusual assets within broad market funds, he says, such as transit hubs and high-end residences. The fund is to include social and affordable housing and economic developments in its infrastructure investments, having recently approved a revised framework for the asset class.
In a recent report for the fund, consultancy PwC highlighted the advantages of investing in the residential sector, such as index-linked cash flows and the fact housing associations are regulated. Strathclyde plans to invest in the asset class via the Pensions Infrastructure Platform, which was set up with the pension fund as founder investor and includes nine other UK pension funds. Earlier this year, Strathclyde bid to acquire a stake in Scotland’s Glasgow Airport as part of the expansion of its infrastructure exposure. This followed a £32m commitment the fund made in December to Lloyds Bank UK Infrastructure Partners.
Allianz Real Estate
• Ideally seeks 10% allocation to logistics and light industrial
• No near-term plans to increase exposure or expertise
So far, Allianz Real Estate only has around 2.5% of its €23bn of assets in property types that could be considered alternatives — logistics and light industrial — and ideally would like to increase this to around 10%, says Charles Pridgeon, chief investment officer. “If you have 2% of your portfolio in a higher yielding sector, then there is a good income yield,” he says.
To date, the institutional investor has not put much money into other alternatives such as student housing, hotels and car parks, he says, because it does not currently have the specific expertise to pursue these property types. “We would need to hire in [expertise],” Pridgeon says, but adds that is not something Allianz Real Estate has plans to do in the short-term.
Though Allianz Real Estate could use external managers to gain these exposures, he says it would first be necessary to understand a particular sector. “We’re not going to throw money at the sector just because a group is a leading player in that sector,” he says. “We need to fundamentally understand what drives that sector.”
But over time, Allianz Real Estate could gain expertise in these alternative sectors, he says, noting that this is what happened with the logistics sector and with retail. Both sectors began as alternatives before moving to the mainstream. Private equity companies are natural investors in alternative real estate sectors, he says, because they are good at injecting growth skills into them.
“With an operational business, if you can scale that up you can drive the margins and make many times the income you can in conventional real estate,” says Pridgeon. But, he remarks, that this is not a traditional area for a big insurer.
• Looking to expand healthcare investments because of client mandate
• Operational component seen as key to alternative property sectors
Co-operative Dutch pension fund service provider PGGM sees alternative real estate sectors becoming — in many cases — more established and therefore more suitable for institutional investment. “Logistics has been important to us for many years but is growing in allocation due to the developments in e-commerce,” says Guido Verhoef, head of private real estate at the €158.5bn pensions provider.
PGGM also invests in student housing as well as senior and age-care [retirement] housing. “Although these have been niche markets, these sectors have become more professional and are getting bigger in size and as such more institutional,” he says. “The key for these types of investments is the operational component.”
Within the healthcare sector, PGGM is exploring more fields to invest in, partly because of instructions by its main pension fund client. “These activities are aimed at ensuring a sustainable Dutch healthcare system,” he says. “Innovations in healthcare, which either support the decrease of healthcare costs or improve the efficiency in the sector, are an important focus of this healthcare mandate that PGGM has been given by our client Pension Fund for Health and Welfare.”
Alternative sectors are particularly favoured by PGGM are logistics, due to their scale and economic impact today, and certain segments of the student housing markets where there are opportunities to partner with public-sector linked bodies, such as leading universities.
“In general there is a lot of capital in the market searching for yield. This applies to all real estate sectors, assets become more expensive, and this is also the case for the logistics sector and student and senior housing.”
While some alternative property sectors are less liquid than others, Verhoef says PGGM is not particularly concerned about liquidity risk in specific sectors, since real estate is by definition an illiquid asset. “Operational risk is by far the biggest risk and should be key in the due diligence process and during the monitoring phase.”