Investor Forum: Liquidity

How important is liquidity in real estate investments? Rachel Fixsen talks to six investors and advisers 

Dutch pensions investment manager MN acts to lessen the risk of illiquidity in property investment, even though liquidity is not key for it in this asset class.

“As a long-term investor and given the nature of real estate, including a certain liquidity premium, liquidity is of relatively low importance,” says Arie Gravendeel, senior consultant product strategy and development at MN. “However, we mitigate the possible risks of it in several ways, through diversification across funds, managers, vintages, etc. Furthermore, liquidity could impose limits on the speed with which we could build up portfolios.”

MN’s strategic real estate portfolios are made up mainly of unlisted investments – direct and funds – and can have up to 25% in REITs. “Our view is that real estate investing is primarily based on the fundamental characteristics of the underlying assets, so the way the same underlying assets are wrapped doesn’t impact longer-term returns,” he says.

Gravendeel says historical data proves this. “In practice, the choices depend on the overall strategic framework of a client portfolio and the size of the total real estate allocation,” he says.

There is a secondary market for closed-end funds, but Gravendeel says this does not mean they can be considered potentially more liquid than open-ended funds. 

“Closed-end funds have the benefit of natural exits – that’s also why we diversify over vintage years – but before that time, the liquidity risk of all investors wanting to get out at the same time should not deviate much from open-end funds,” he says.

MN sees the choice for listed real estate depending mainly on investment beliefs and strategic reasons, and less on liquidity. “We have made strategic choices on the markets we want to be in; these choices have not been influenced by liquidity,” says Gravendeel. 

A significant part of Invesco Real Estate’s assets under management is in the most liquid form of real estate exposure – global listed real estate securities, says Andy Rofe, managing director Europe at the firm.

“We have a large client base that wants to access real estate through these funds, but they obviously correlate more closely to the equity markets rather than the real estate side,” he says.

Invesco Real Estate manages the majority of its exposure to real estate through direct investment in unlisted real estate funds and accounts, which produce returns that are, arguably, more closely correlated to the underlying property markets, he says.

This depends on the wrapper for the investment product, whether the client base is either retail or institutional, as well as how frequently those clients require the asset to be priced, he says.

Real estate investment products that require liquidity, such as some UK defined contribution funds, are somewhat problematic in the market, because they essentially involve an attempt to put a liquid wrapper around an illiquid asset class, Rofe argues.

“They have to have a certain proportion in liquid instruments, which doesn’t increase performance but certainly increases volatility,” he says.

Having a mix of illiquid real estate assets and liquid instruments within a fund does inevitably lead to a drag on performance, he says. “Fundamentally, real estate is an illiquid asset class, and you get a premium for that,” he says.

“It’s no accident you get about twice as much income return from real estate than you do from equities.”

Within direct real estate investment, Rofe says the best way to have relatively high liquidity in a portfolio is to focus on core assets in good locations.

“Simply because they are the most straightforward to buy and sell, the potential market is larger and you can generally buy them with equity, or there is a high degree of availability of debt which, again, improves the selling ability of the assets by widening the buyer pool,” he says.

Allianz Real Estate, which advises the insurance companies of the Allianz group, includes property investment funds as part of its recommended asset mix, which account for just over 10% of the overall equity portfolio, says CIO Olivier Teran.

While funds can, in some cases, be easier to buy and sell more quickly than direct property holdings, Teran says the liquidity of these fund investments varies.

“With open-ended funds there are generally provisions for coming in and coming out, meaning there is some sort of liquidity. But with closed-ended funds, the liquidity is more complicated because you’ve signed up for the strategy to be deployed until the term of the fund,” he says. 

Although there is a secondary market for closed-ended fund investments, with specialists looking at buying from those who need to exit, these exits have historically been done at a discount, he points out.

But, in general, real estate returns contain an element that compensates investors for it not being an instantly tradeable asset, Teran says.

“This remains a sticky asset class for which there is a illiquidity premium, and part of investing in real estate is to capitalise on this,” he says. “Not only do you get reasonably stable assets but, clearly, part of the return you can extract from them comes from the premium.”

But Allianz Real Estate is helping deploy money for an insurance group that is a multi-asset-class investor, says Teran, and if liquid investments are needed in the overall portfolios, then bonds or stocks will be used.

“We are core to core-plus investors, so we are investing in liquid markets and desirable sub-markets,” he says. “We don’t go for the type that are illiquid, and we tend to rotate those ones out of the portfolio. Liquidity is there to help us streamline the portfolio and rotate good quality assets.”

On the other hand, as a long-term investor, the firm is also patient, he says. “We are not facing situations where we have to sell assets, so if the liquidity is not there, we can always wait for longer to sell.”

Even though most of Willis Towers Watson’s pension clients can tolerate illiquidity in their investments, the consultancy does encourage them to have a proportion of their property investments in liquid instruments, says Paul Jayasingha, consultant at the firm.

“It has more to do with the fact that REITs are an incredibly useful way of getting global diversification easily,” he says.

Because property investment requires local expertise, pension funds keen to invest in property globally would either have to use several specialist managers around the world, or buy into REITs, he argues. “A large part of prime real estate in Hong Kong and New York is held by listed property companies, and very prime Tokyo real estate is held to a large degree by listed property companies.”

Large dominant shopping centres would also be hard to access without using REITs, simply because some of the biggest owners of these are listed REITs, such as Westfield in Australia, Simon Property in the US and Unibail-Rodamco in France, he says.

Among direct property assets, prime and core tend to be more liquid than other types, even in a very difficult market. “You would still be able to sell a retail property on Bond Street in such a market because it tends to be easier to sell them anyway,” he says.

Holding prime property is a way to get more liquidity. Another way is to invest in smaller lot sizes, which opens up the range of potential buyers, he says.

While pension funds are long-term investors by nature, there are some that can’t afford to have much illiquidity in their portfolios, Jayasingha says. “An investor looking for a company to buy out it liabilities, and therefore needing to purchase an insurance contract, might be better off having assets it can sell quickly,” he says.

Also, most of the platforms offering defined contribution pension funds on the UK market require daily dealing, and if there is no cash buffer, a proportion of the investments have to be liquid, he says. “If you’re tying your money away for 30 years, this doesn’t make much sense, so it would be nice if the distributors and platforms addressed this problem.”

For the real estate portfolio of the NN Group of insurance companies, liquidity is – theoretically at least – unimportant. In practice, though, Marieke van Kamp, head of real estate and alternatives at NN Group, is happy that its asset mix means there is always a degree of liquidity from one side of the portfolio or the other.

“We choose to invest into non-listed real estate because of its qualities and characteristics,” she says. “One of those is the diversification benefit within a wider portfolio, and that is partially driven by the illiquid nature, so we deliberately choose to invest in a non-liquid asset class, through non-liquid structures.

“However, within the non-listed real estate asset class, there are different types of holding structures, some of which are more liquid than others,” she says. Because of this, she says, the insurer has decided to build the portfolio as a blend of directly held assets, joint ventures, smaller and larger funds. 

While the latter three types have some liquidity in good times, she says, direct assets have liquidity in bad times. 

“Because even though we would like to steer the portfolio on what is happening in the real estate market, we could need some liquidity in times when, from a real estate perspective, it is not easy to have liquidity,” van Kamp says.

To date, van Kamp’s team has not included any listed real estate in its portfolio. “The volatility that listed real estate brings, that on the short horizon is more driven by equity market movements relative to real estate market movements, is undesirable,” she says.

It is much more important to capture the illiquidity premium of the asset class, van Kamp stresses. “We want to take into account a 10-year horizon and view,” she says.

“But, in times of stress, the illiquidity is a very unhelpful feature – values are going down, and will continue to do so without being able to hedge or step out. However, this is just something that has to be lived with, she says.

Listed real estate investments may have a liquidity advantage over some other types of property investment, but for Cornel Widmer, head of group real estate investment management at Zurich Insurance Group, equities and bonds are a preferable way to meet liquidity needs.

“It is not the liquidity which justifies real estate in the context of a multi-asset-class portfolio,” he says. “Shares and bonds are better suited for that function.

“What we want to achieve in real estate is a certain excess return, as well as a low correlation to the other asset classes in the overall portfolio,” he says.

Having long-dated liabilities, Zurich has the risk capability of capturing the premium in real estate markets due to illiquidity. “We focus our investments on directly-held real estate assets,” Widmer says.

The liquidity of financial instruments that are related to real estate assets is not one of the insurers main concerns, he says.

Widmer notes that investments in transparent markets, which have a large stock of property assets, are in general more liquid than those in other markets. Examples of this are the office markets in London, Paris, Tokyo, or offices in 24-hour cities in the US.

But if investors are looking for investments to be more liquid, the most important factor is the position within a particular market, Widmer says. “Our experience is that an excellent micro location always finds its trade,” he says.

It is hard to generalise how liquid real estate funds can be, he says, since funds are as different as they are numerous. “One should simply remember that when investors try to exit a certain investment at the same time, liquidity is normally in short supply – even when the investment had been considered liquid a little earlier,” he says. 

“Liquidity is less important, as investing in real estate is a long-term play, based on the fundamentals of a specific market,” Widmer says. “A real estate investor should have the risk capacity to hold an asset in a less liquid market situation and, of course, one should get compensation for this.”