EUROPE – Investors' willingness to allocate to listed real estate is "in structural decline" – and it will continue unless the industry can come up with products investors want, according to Bernd Stahli, head of European property research at Merrill Lynch.

Speaking at a recent EPRA event, Stahli attributed the continuous decline to concerns over diversification and uncompetitive returns, the fact that property is management-intensive, and the absence of an inflationary driver.

Moreover, six decades of data show real estate's track record as an inflation hedge to have been at best "mixed".

Pension funds have been less willing than insurers to allocate at least since the 1970s, and the gap has widened since 2004.

Pointing to equivalent short-term volatility and a significant correlation with non-property equities in recent years, Stahli said the absence of tail winds from the UK economy and interest rates created significant near-term challenges for the sector.

"With tail winds, it could be tempting to avoid making the hard decisions," he told IP Real Estate.

"In recent years, we have seen these hard decisions being made because self-help was the most obvious way to drive shareholder value."

The former APG portfolio manager said listed property could attract more interest in the listed property sector, but only if it could "up its game" by delivering a product investors wanted. 

That product would have to reduce leverage in order to reduce volatility and the high correlation with equities, compensate for higher operational leverage as a result of short leases, and lock in long-term debt while it is still cheap.

Stahli confirmed to IP Real Estate this week that some form of REIT would be the most likely candidate. But he added that existing REITs would need to adapt to investors' appetite for income-based returns.

"REITs are one of the most efficient ways to hold real estate, so yes, REITs would be likely," he said by email. "The difference, if any, would be that more REITs appreciate that income is why most investors first and foremost invest in REITs."

Stahli acknowledged in his presentation that property was "a business, not a collection of assets".

But this week he downplayed potential investor reluctance to take on corporate risk by investing in REITs.

"Corporate risk is not a major issue because capital markets provide scrutiny and discipline," he said.

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