Listed REITs can mirror direct investments, but do they they belong in property portfolios? Rachel Fixsen talks to six investors and advisers
• Listed and unlisted real estate remain fully integrated
• Dutch manager shifting to residential, logistics
For Dutch pensions investment manager APG, listed and unlisted real estate are very much the same type of asset and belong together in a portfolio.
“Our strategy hasn’t changed, we keep listed and unlisted fully integrated and have done so for quite a while,” says Patrick Kanters, managing director, global real estate and infrastructure at APG Asset Management.
Kanters says he was surprised to see Norges Bank Investment Management, which manages Norway’s sovereign wealth fund, separating the two in its financial reporting.
“There is an increasing amount of evidence, with new reports coming out every quarter, that there are very high correlations between listed and unlisted real estate,” he says. “It’s common sense that even though the real estate is wrapped differently, the structure of the asset is the same.”
APG has been maintaining, over the past year, a gradual shift towards residential and logistics at the expense of office assets. “We have been investing in PRS [private-rented sector] and also student housing, and have increased our investments in logistics, and our total allocation to office has declined over the last year,” Kanters says.
Residential has become increasingly attractive in a growing number of markets, he says. “Quite a few countries don’t have an established PRS, and that’s why we have entered these markets, particularly in the UK, Finland and Spain. It is the same with student housing in Europe, but also Australia — where we have initiated the creation of new platform alongside strong operators.”
APG is buying more logistics assets to try to capitalise on the e-commerce trend by owning warehouse space, he says. “Against our peers and the benchmark, we have a typically lower allocation to office. We see office very much as a timing play – an opportunistic investment – because it is very difficult to make a profit holding this sector over time.”
The most important changes to APG’s property asset allocation right now, Kanters says, take place within sectors, rather than between them – ensuring it has the right assets in its retail exposure, for example, by adding regional malls.
• Studies show listed property investments follow underlying assets
• Finnish pension fund aims to increase real estate allocation from 3%
There is a big debate about whether listed real estate is more of an equity or property investment, says Johannes Edgren, alternatives portfolio manager at VER, the State Pension Fund of Finland.
“But if you look at the studies, they seem to show that in the long term they do tend to follow real estate,” he says.
Until recently, the €19bn pension fund has only had a small allocation to real estate, and all of its investments in the asset class are made through funds or in other indirect ways.
“We have been increasing our property investment over the last few years and are building up the allocation to listed,” says Edgren.
VER would like to increase the allocation further from its current level of around 3% of the overall portfolio.
“In today’s world we wouldn’t mind if it was slightly overweight,” Edgren says. “What we are looking at is the income characteristics of listed and the income or dividend has been quite attractive at around even 5% or 6%. If you are able to tolerate the fluctuations, the yields are attractive.”
Another point in favour of listed is its liquidity, says Edgren, which is useful if you want to make quicker allocation changes.
“From an allocation perspective, however, listed real estate investments are part of our equity allocation, but they are managed within the alternatives team – so it is a collaboration between the teams,” he says. “They are not a perfect substitute for unlisted, because of the volatility,” he says.
Geographically, the real estate mix at VER has been fairly stable over the past year. “The vast majority of our portfolio is in Europe, and we have some exposure to Asia,” Edgren says. “I would expect it to remain like that going forward, and the only change in the future would come if we were to consider the US, but we have no such plans right now.
“By sector, we have been increasing our allocation towards residential and logistics and have not looked so much at office. But, going forward, the office sector is more interesting.”
• Listed acts like equity in the short term but real estate in the longer run
• Boosted residential and retail investments in certain German cities
For Zurich Insurance, investing directly in real estate serves its purposes better than taking an indirect route, says Cornel Widmer, global head of real estate at the group’s investment management operation.
Zurich Insurance is aware of the correlation and the characteristics of listed and non-listed property, he says. “We think listed real estate behaves like equity in the short run and like real estate in the longer run,” he says. “This is why we have a preference for holding the assets directly, with full ownership and control.”
Widmer says: “We have a minimum exposure to listed real estate through REITs, and the vast majority of our real estate exposure is through assets that we manage ourselves and a minority is invested through separate account mandates.”
Having carried out more than $2bn of property deals in 2016, Zurich Insurance has been increasing its allocation to real estate. “Our investments to real estate currently stand at approximately $13bn, or 6% of our investment portfolio, and we are planning to increase our allocation to real estate further,” he says.
Different sectors in different geographical locations are targeted based on factors such as their liquidity, transparency, growth potential and potential to improve risk-adjusted, long-term returns.
“With this approach, we have, for example, increased our investments in the residential and retail sector in selected cities in Germany, and kept on buying logistic assets in the US,” he says.
The property portfolio is well-diversified geographically, Widmer says, with a focus on stable core markets such as Germany, Switzerland and the US.
“We also hold assets in Austria, the UK, Chile, Italy, Spain, Portugal, Holland and Malaysia,” he says. “We are currently considering other markets such as Australia, Japan, Canada and further countries within the euro-zone.”
Even though it is easy to calculate a meaningful allocation to real estate, sourcing good-quality assets at fair prices can be a challenge, he says, because there is a large amount of capital targeting a limited stock of assets. “We try to stick to our underwriting discipline and benefit from local knowledge and relationships with teams on the ground or best-in-class external asset managers,” Widmer says.
• Neither listed nor unlisted real estate is inherently better
• One lesson from the Brexit vote was to avoid open-ended funds
The choice for investors between listed and unlisted real estate depends to a large extent on whether daily pricing and liquidity is needed, says Duncan Owen, global head of real estate at Schroders.
“We do not believe that one type is inherently superior,” he says. “Schroders Real Estate manages a range of different vehicles including unlisted balanced core funds, unlisted specialist funds and partnerships. We are the manager of three real estate investment trusts (REITs) in the UK, continental European and Swiss markets as well as also investing globally via a programme of real estate securities.”
“There are also some markets – for example, prime Hong Kong offices – or niches which you can only really access by investing in a REIT.”
Owen adds: “Clearly, one of the lessons from last summer’s Brexit vote is to avoid authorised open-ended funds, which rely on cash holdings and REITs to provide daily liquidity.” He says Schroders believes these structures are fundamentally flawed.
Geographically, the firm’s main focus in real estate is on cities, rather than countries. “We think that the key ingredients which make a successful city are a diversified economy, a deep pool of skilled labour, strong universities, good infrastructure, a pro-active local government and good amenities,” he says.
“Inevitably, this means that we tend to favour big cities like Berlin, London, Paris and Stockholm, but there are also a handful of smaller cities – Bordeaux and Cambridge, for example – which share some of the same characteristics.”
As far as sectors go, Schroders prefers office to retail generally, because of the structural challenges facing retail in terms of the diversion of sales online and the switch from materialism to experiences.
In the office sector, Schroders’ main strategies are either to undertake refurbishments and “manage back to prime”, or to invest in locations such as Bloomsbury in London and Ostkreuz in Berlin, which are benefiting from new infrastructure, or other regeneration.
“We also like multi-let industrials and alternatives, although it is important to recognise that the factors which originally made an alternative sector attractive will change over time and to keep hunting for the next opportunity,” Owen says.
• Avoids liquid real estate, which is closer to low-volatility equities
• Investors putting emphasis on defensive, income-focused strategies
Investment consultancy Redington steers clear of listed property investments for its pension fund clients, taking the view that these instruments do not adequately expose portfolios to the characteristics of real estate.
Pete Drewienkiewicz, managing director of manager research at the firm, says he entirely agrees with the Norwegian Government Pension Fund Global in its decision to stop including listed real estate in its real estate reporting this year. The sovereign wealth fund’s move suggests that it sees these listed instruments as more equity-like than property-like.
“We do not invest in liquid real estate,” says Drewienkiewicz. “This sector has characteristics more akin to low-volatility equity investment than to property,” he says.
In the past year, institutional investors’ allocations to real estate have changed little, according to Drewienkiewicz. ”Within real estate we continue to see an increased emphasis on more defensive and income-focused sectors – for example, the long-lease sector,” he says. “We believe this is likely to continue, notwithstanding the very public struggles of the supermarket sector which makes up a share of this investment area.”
He observes that there has been an increased – and to some extent renewed – interest in global investment in real estate – as opposed to a domestic focus – as a result of recent FIRPTA (Foreign Investment in Real Property Tax Act) changes in the US. “But this has been somewhat offset by increased caution in investing overseas following the significant currency swings we saw last year,” he notes.
One of the main challenges facing real estate investors in the current environment is currency hedging, he says, adding that this has become an even more significant challenge in the wake of 2016.
Real estate debt is now becoming more attractive for investors, he says. “After a lack of interest for the last 18 months, we believe that real estate debt has started to look more appealing, given the dramatic spread tightening seen in public credit markets in 2016,” Drewienkiewicz says.
Principal Real Estate Investors
• Listed, unlisted share basic drivers: cash flows, interest rates, tenant demand
• Global central bank easing has sometimes exaggerated divergence
Prices for public and private real estate can move further apart in some circumstances, but they are fundamentally driven by the same factors, according to Indraneel Karlekar, global head research and strategy at Principal Real Estate Investors.
“Principal is an active investment manager across all four areas of commercial real estate investment: private equity, private debt, REITs and CMBS,” he says.
Listed real estate totals $12.5bn of the firms’ $71.8bn in assets under management. Of the $59.9bn of real estate equity it manages, $12.5bn or 27% is listed and $34.1bn or 73% is unlisted.
“The underlying drivers of REITs and real estate are the same: real estate cash flows, interest rates and tenant demand,” Karlekar says. “We believe REITs represent real estate investments and also believe it is more efficient in price discovery, relative to private markets.
“As a result, we use price divergences between public and private — which do occur — to our advantage in our more actively managed accounts and strategies, by reconciling such differences on a real-time basis.
“We evaluate the discount or premium to NAV and, more importantly, what it implies. We would acknowledge that global central bank easing and some idiosyncratic factors have amplified this divergence from time to time.”
Karlekar says Principal Real Estate Investors has an active approach to determining relative value within the real estate asset class. “On a monthly basis we combine macro level research with street level insight to determine where we see best value on behalf of our clients across debt/equity and private/public aspects of real estate investment,” he says.
Right now, the firm sees industrial property offering the best relative value, followed by select multi-family.
“Conversely, we believe the office sector is least compelling from a relative-value perspective, given pricing and ability to grow rent,” says Karlekar.
With a focus on the US only, he says Principal Real Estate Investors currently favours the West and Southern areas of the country, given the demographic and employment changes that are having a positive effect on those areas.