With prime markets around the world so steeply priced, where are real estate investors finding value today? Rachel Fixsen speaks to six funds

Arnaldur Loftsson
Frjalsi Pension Fund

• Iceland commercial real estate prices have risen sharply in recent years
• The fund aims to increase its foreign allocation once capital controls are lifted

Iceland’s Frjalsi Pension Fund has been focusing its property investment on domestic commercial real estate, mainly because of capital controls barring foreign investments, says Arnaldur Loftsson, managing director of the fund.

“Driven by strong economic growth, domestic commercial real estate prices have risen significantly in recent years as demands outstrips supply,” he says.

“The market is therefore considerably more expensive than it was in late-2011, when Frjalsi Pension Fund entered the market. However, with the favourable economic outlook, prices might not be considered to be too high, although the potential upside is less than before.”

The rise in prices has made the domestic commercial real estate market less appealing than it was. This has prompted the pension fund to shift its investment strategy from a sector-wide approach, aimed at building exposure to economic growth, to a selective approach, seeking the best opportunities in the market. 

Arnaldur Loftsson

“In a small market, however, these opportunities are becoming harder to find,” he says. “We are therefore making fewer investments in commercial real estate, although it is still considered an important part of our portfolio.”

 Using the selective approach, the Frjalsi fund has been focusing on investing in well-located landmark properties with long-term inflation-linked lease contracts to operationally sound leaseholders, low vacancy rates and predictable cash flows for years to come, he says. “The strong links between the return on these assets and inflation provides an inflation hedge for the fund’s inflation-linked liabilities,” Loftsson says.

These assets also give the fund diversification, which improves its risk-adjusted returns. These are both valuable characteristics for a pension fund to have in Iceland’s volatile economic environment. 

Loftsson says: “As it gets harder to obtain these assets at favourable prices, we are looking into shifting our focus beyond the commercial real estate market by identifying trends that will persist through the economic cycle. With the lifting of capital controls in sight, the fund aims to increase its allocation into foreign assets, including foreign real estate.”


Lisa Lafave

• Moving away from core to more value-add opportunities
• Continues to invest in logistics and residential with a build-to-core strategy

With high property prices worldwide, Canada’s Healthcare of Ontario Pension Plan (HOOPP) is turning to sectors in the market where it can find assets with solid fundamentals.

“Pricing appears to be at an all time high globally,” says Lisa Lafave, senior portfolio manager, real estate at the CAN$63.9bn (€43.4bn) pension fund. “We are tending away from core to more value-add opportunities where property fundamentals are strong. Product types we continue to invest in are logistics and residential with a build-to-core strategy.”

HOOPP is busy shifting investment from its domestic market to the US and Europe to improve diversification and increase returns. HOOPP plans to sell select domestic assets to recycle the proceeds into higher-yielding international strategies.

“Stock selection is key in a low-growth environment,” Lafave says. 

lisa lafave

She predicts that real estate prices will remain high for the time being. “The market will continue to be very competitive with the wall of money looking to place investments,” she says. When prices are high, property investors do well to remain disciplined about their underwriting, she says, as well as understanding property fundamentals.

HOOP’s strategy is to buy and hold well-located, well-leased assets that have a stable and predictable income. The pension fund diversifies its portfolio by geography and asset type and, apart from the investments in more than 200 Canadian properties, it also invests in non-domestic properties and funds. Its strategy also involves boosting the performance of its portfolio by developing new buildings. 

HOOPP invests in the asset class for diversification, income and cash flow. “As a pension plan, real estate continues to play a big part of paying the pensions,” says Lafave.


Mark Fawcett

• Cutting relative exposure slightly because of high pricing
• Employment growth is supporting the office sector

UK auto-enrolment pensions provider NEST is reining in its property investment due to the high level of pricing, even though it sees many factors supporting the future growth of the market.

“We are reducing our real estate exposure slightly as we are beginning to see attractive opportunities in other asset classes,” says CIO Mark Fawcett.

“However we will not sell any assets – we just will not allocate quite as much of our strong cash inflows into property. Having said that, we expect yields to stay around the 5-6% level and consider property to have attractive relative valuations when compared with many other asset classes – for example, government bonds.”

NEST’s real estate investment is mainly in UK commercial property, through a pooled fund managed by Legal & General Investment Management.

While prices have risen in recent years and yields are expected to stabilise this year, Fawcett says demand for commercial space is relatively healthy and there remains limited new supply coming to the market — all of which will support the rental market. 

mark fawcett

“We expect employment growth to provide support to the office sector,” he says. “Office rental growth – especially in London – is still leading the industrial and retail sectors and we expect this to continue. We think the retail sector may continue to struggle in the UK, although the best locations are now starting to see improving levels of tenant demand.”

NEST is considering entering new areas of the real estate market. “We are discussing with our manager the potential to add residential build-to-let property into the portfolio,” Fawcett says. “There is a significant housing shortage in the UK and we believe that the fund can support this clear social need while delivering acceptable risk-adjusted returns to our members.”

Over the next year or two, NEST expects the supply of office space to increase. “This can be absorbed if economic growth continues to generate tenant demand,” he says.


Richard Gwilliam
M&G Real Estate

• Still scope for rise in property prices to continue
• Potential seen in the UK outside London

Although real estate prices have been rising, they are below historical highs, Richard Gwilliam, head of property research at M&G Real Estate, says.

“We have had a good period recently in the last two or three years, but if you compare average capital values to 2007, they are still 15% lower,” he says. “I think there’s still scope for the rise in property prices to continue, but it may not be at the same pace as in the last few years. We are not at the top of the market and there is space for further growth.”

In the UK, yields on London property have dropped to record low levels, and compared with other parts of the country, real estate in the capital city is priced at a high level, Gwilliam observes. “There is potential for other parts of the UK to catch up.”

The US real estate market is ahead of the UK in the property cycle, he says, having given six consecutive years of double-digit returns compared with three consecutive years in the UK.

richard gwilliam

“European property in particular looks in the earlier stages of its cycle and there is further potential for more growth in this market,” Gwilliam says, adding that the real estate yield spread above government bonds in parts of Europe seems to provide quite a compelling case for this.

M&G increased its allocations to real estate over the last few years, he says, and although it is not accelerating that investment right now, it is not pulling back either.

Prices for core assets in central London may be overpriced, but elsewhere in the country there are opportunities, Gwilliam says, with fringe areas of London being redeveloped, for example.

“London had been benefiting from strong occupier demand for some years, and it’s only more recently that we’ve been seeing demand coming back for other parts of the country,” he says. “A lot of regional centres are seeing a lack of supply, which is pushing up rents and so you can get more attractive yields.”


Stephen Tross

• Fully-priced markets can yield otherwise unavailable opportunities
• When yields are compressing, investors must be very selective 

Investing in defensive properties with low leverage, or buying properties that have secure long-term cash flow is the best way to invest in real estate at the top of the market cycle, says Stephen Tross, managing director of international investments at real estate investment manager Bouwinvest.

Tross offers a reason why a more expensive stage in the property-market cycle can actually be a good time to buy. “If markets are fully priced, you might be still able to invest in the best products in the best markets in order to hold them as strategic positions for the long term – or even ultra long term – because assets like this are simply not available at other points in the cycle,” he says.

stephen tross

Tross says Bouwinvest invests internationally, mainly in core real estate assets in major cities through club deals, joint ventures, listed, and unlisted funds. The manager prefers to take significant stakes in investments, and to play an active role in the funds it invests in, he says.

“While we aim to hold our investments for the long term, we also take a strategic view and will exit our positions earlier if we believe this is appropriate and will maximise returns,” he says.

“When yields are compressing you have to be very selective, but we are flexible in when, where and in what we invest. With such a range of diversified markets to chose from and with over €1bn to deploy globally in the next few years, I don’t see us slowing down anytime soon.”

Even though it aims for the best possible diversification to spread risks, Bouwinvest is focusing on a few real estate areas, including Asia Pacific.

“Major cities here are still offering interesting opportunities, despite the slowdown in China and an increasing number of Asian real estate markets are becoming more developed and therefore investable for us,” Tross says. 

Over the long term the biggest growth in values will be in the major Asian cities, he predicts.

“Bouwinvest is slowly increasing the proportion of these assets in its portfolio to reflect this,” he says.

Other areas the manager is focusing on are listed real estate – which is a growing part of its portfolio – and niche markets, such as student housing, logistics, hotels and healthcare.


Tomi Aimonen

• Some markets and areas are fully priced and starting to cause concern
• Sees value in some markets and property types

The European and US real estate cycles are now at an advanced stage, says Tomi Aimonen, head of real estate investments at Finland’s Ilmarinen Mutual Pension Insurance Company.

“But considering the relative value real estate provides in comparison to the other major asset classes, we see that there is still some room for prices to move higher,” he says. “There are definitely markets and areas that are fully priced and beginning to raise some concern.”

Ilmarinen is being selective on new investments because of overpricing, but it sees value in some markets and property types.

“There are certain areas of the market which we are staying clear of but will remain active with new investments for the foreseeable future,” Aimonen says. “The long-term investment perspective we have provides us with increased flexibility to slow down on new investments if we start feeling uncomfortable about the level of heat in the market, but currently we have not reduced the investment volume target.”

tomi aimonen

He says the market situation has not had a big impact on the insurer’s choice of target sectors or geographies. “The focus is still on markets where fundamentals remain strong – both in the broader economy and respective real estate markets. Supply-constrained markets with historically stable rental values offer long-term investors like ourselves good opportunities to deploy capital.”

Aimonen believes that over the next one to two years, prevailing strong capital flows to real estate will keep the upward pressure on pricing, and cause spreads to narrow between core and more risky assets. 

“Areas like the Nordics will get more attention due to pricing. Niche sectors and strategies will increase in popularity as more established markets and traditional property types are further saturated with capital.”

 What is the best way to invest in property at the top of the cycle? “At this point of the cycle you need to go back to basics,” says Aimonen. “Focus on real estate fundamentals, such as maintaining high occupancy at sustained rental levels.”