Investor Forum: The rationale for going public

Why are institutions investing in real estate markets, and what are the pros and cons? Rachel Fixsen talks to six investors and advisers

Taiwan’s Bureau of Labor funds invests in both REITs and other listed property securities — with the TWD2.5trn (€60bn) Labor Pension Fund (LPF) having been a pioneer of alternative investment among government funds in Taiwan, says Huang Chao-hsi, director general of the bureau.

He says the LPF began by investing in global REITs in 2011. It was drawn to the vehicles because of their liquidity, profitability and transparency. 

Since March 2012, the fund has outsourced $1.25bn (€933bn) to global REITs in batches. By the end of May this year, the REIT mandate reached $1.53bn in net assets, generating an average 29.8% return, Huang says, compared with the FTSE EPRA/NAREIT Global benchmark of 27.7%.

“As the global economy continues its slow recovery and money becomes plentiful in major countries, we will raise the position gradually in order to increase the long-term return of the fund,” he says.

“The Labor Retirement Fund had also selected a $200m global REITs mandate and will allocate the money, depending on market conditions,” he says.

Huang sees many advantages in REITs – stable dividend income and growth potential, as well as liquidity, the pricing transparency resulting from the daily mark-to-market and the diversification.

“Real estate securities have offered above-average dividend yields due to the regulation that most of income should be distributed to investors,” he says. “Real estate securities also have a history of consistently raising their dividends, resulting from cash-flow growth that can come organically from rising rents and occupancies, or externally from development and acquisitions.”

He lists as a disadvantage the higher recorded volatility compared with direct real estate because of the daily pricing, but counters that the lower volatility from direct real estate is misleading, since it is based on appraisals.

“The usefulness of using listed RE securities for certain geographic areas depends on transparency, yield, local regulation, etcetera,” says Huang. It varies, depending on the conditions of each market as well as the fundamental investment targets, he says.

---

“Generally speaking we’re in a period right now, according to fund flow data, when funds have been flowing back into REIT funds,” says Steve Buller, portfolio manager at Fidelity Investments. 

Buller manages the Fidelity Real Estate Fund, which has $3.9bn in assets under management, as well as more than $7bn in a property fund for Japanese investors.

The Fidelity Real Estate Fund invests in a combination of listed RE securities, including REITs, but none of the firm’s property funds invests in non-listed property.

“For institutional investors there is a phenomenon that has been present for the last couple of years – whether sovereign wealth funds, pension funds or other investors – where benchmark weightings in real estate securities have been increasing,” he says.

Liquidity and transparency are the two primary differences between listed real estate and non-listed, in his view.

“Being a publicly-listed company, you are required to offer quite a bit of transparency – stating what your strategy is, for example – but with other types of non-listed funds, the transparency is not so good,” he says.

In general, many non-listed real estate funds are not subject to much governance, Buller notes. “You don’t have the ability to have proxy votes or to change management.”

For Buller, the arguments in favour of listed real estate are clear, and he suspects a kind of inertia keeps some institutional investors in direct property.

“Some institutional investors often invest in direct real estate because they have a team in place to do that,” he says. “In some ways there is a bit of job preservation going on,” he says.

“The second reason is that there’s a perception that there’s a lack of volatility there — it looks better in their asset allocation to put in low volatility.”

In a recent research paper, Buller and colleagues concluded that, in the short run, public and private real estate returns could diverge because of shocks and features that were specific to each investment type.

But investors with long time horizons could afford to be indifferent between holding REITs or private real estate, according to the research.

---

Last year, the The UK’s National Employment Savings Trust (NEST) said it would allocate a fifth of its total investment to Legal & General’s Hybrid Property Fund, which currently has around 23% of its assets in global listed real estate companies and REITs.

Liquidity and diversification, rather than the prospect of higher returns provided NEST with its primary motives for putting money into listed property as well as direct bricks and mortar, according to Mark Fawcett, CIO at the auto-enrolment workplace pensions provider. 

“Once you adjust for leverage, the returns should be similar depending on the sector,” he says. “So the advantage is for us is, firstly, liquidity.”

He continues: “This was one of the reasons we went down the route of blending direct and indirect property, particularly as we have very large cash flows every month and we can invest large amounts directly into REITs — the direct market isn’t able to absorb that.

“Secondly, it gives us global exposure.” 

Listed property investments, he says, are a way of having knowledgeable locals do your real estate investment for you, allowing you effectively to have a local presence in global markets.

Fawcett acknowledges that, short term, investors in REITs do have much more volatility than is the case with direct investments, because they are listed and have equity-type structures. “But the difference in the volatility is somewhat overstated, because direct property doesn’t trade as frequently,” he contends.

As with all investments, you have to understand the character of what you are investing in, Fawcett says. “We’ve gone down a passive tracker route, so we’re not going to outperform — or at least not significantly — but we will get good diversification at low cost,” he says. “Because it gives us global exposure, we think it’s worth the trade-off we’re making.”

Although taking an actively managed route with REITs might arguably result in better performance, Fawcett has found costs in the actively-managed REITs sector to be comparatively high.

Fees for global REITs that are managed actively are actually higher than they are for UK direct property managers. “This struck us as curious considering all the resources you need for direct,” he says.

---

Institutional and other types of investor often have biases in their direct property investment, and adding listed exposure can adjust these, according to Dirk Söhnholz, managing director of Germany’s Veritas Investment.

“Many investors have domestic real estate exposure with a private-investor tilt to housing and an institutional tilt to office,” he says. “Therefore, most investors can benefit significantly from adding a global diversified listed real estate exposure to their portfolio.”

Some sophisticated investors such as Dutch pension funds allocate a significant part of their real estate portfolio to listed real estate, he notes. 

Veritas Investment offers a mutual fund investing globally in REITs and listed property equities.

“We agree with recent research from the Swiss Finance Institute that, in the medium term, listed real estate is very similar to direct real estate investments,” says Söhnholz. “Short-term, it is more like an equity investment.”

Listed real estate is, he says, the most efficient way to achieve a diversified global real estate exposure, while the major disadvantage of the investment type is its relatively high potential volatility in the short term.

But while a case can be made statistically for listed real estate boosting broader property portfolio returns, he observes that this very much depends on the time periods, regions and segments used for the analysis.

“In 2008, listed real estate suffered so much because it was easy to sell,” he says. “This may happen again in the next real estate crisis, but at least you are able to sell, if you want.”

---

Dutch pension fund service provider PGGM has €9bn invested in listed real estate securities on behalf of its clients in a global listed real estate fund. 

Hans Op ‘t Veld, head of listed real estate at PGGM, says both listed and unlisted property investments have their place in an investor’s overall property exposure. “The challenge to investors is to ensure that both instruments are used efficiently,” he says. To make sure this happens, he believes investors need both resources and to be of a certain size.

“Ultimately, both listed and unlisted real estate are used to achieve exposure to the attractive characteristics of real estate in the investment portfolio,” he says. “As long as those characteristics are delivered by the vehicle efficiently, there is no reason to limit the exposure to only one instrument.”

From the product-availability side too, it is good to have both instruments in a portfolio, Op ‘t Veld argues. “Listed real estate companies tend to be large and established, whereas unlisted real estate can tap smaller niches and/or, business models unavailable in the listed markets,” he says. 

While it has been said that including listed real estate can boost overall property returns in a portfolio, Op ‘t Veld stresses the importance of understanding the sources of risk and return. 

“The wrapper itself cannot be the sole explanation for the return differential,” he says. “If better returns are achieved through better asset quality, outstanding asset and property management, a lower cost of capital, moderate remuneration and good governance, I would agree. However, it could also be a mere reflection of increased leverage and excessive operational risk-taking.”

Although he does not think the latter is the case, Op ‘t Veld underlines the need to grasp the reasons for the performance differential.

Another attribute of listed real estate — and one that is becoming more important — is sustainability and governance, he says. Investors, including PGGM’s clients, are increasingly scrutinising policies within all real estate investment vehicles in these terms, he says. “This is an integral part of the assessment whether to invest through the unlisted or the listed route,” he says.

---

Listed real estate is a proxy for direct real estate and offers real estate returns as long as investors are willing to look at their exposure over a time horizon of three years or more, says James Maydew, deputy head of global listed real estate at AMP Capital.

Apart from liquidity and low cost, he contends that one of the advantages of the listed real estate markets is that they have some of the best quality management teams on both the asset and capital side. This drives their portfolios harder and achieves the best returns, he says.

Added to this, listed real estate companies own some of the highest quality assets in the world, he says. “As a philosophy we believe quality real estate will outperform secondary real estate through market cycles,” says Maydew.

AMP Capital was one of the first managers to set up a global REIT fund and now has AUD6.2bn (€4.3bn) in listed real estate.

“We believe it should be thought of in the same bucket as direct real estate, as the various studies show an allocation to listed real estate lowers risk and improves your returns,” he says.

Maydew also points towards the potential growth of the REITs market. “Only about 10% of the world’s real estate is listed on the stock exchange and many countries are still yet to enact REIT legislation,” he says. “This all adds to a growing landscape with new countries and sectors to choose from.”

He says although listed real estate should not be viewed as a short-term investment, the asset type is in a sweet spot right now.

“GDP growth is improving globally, the transmission mechanisms in this environment is: more demand by tenant for space drive rents up and vacancies fall,” he says.

“This drives earnings growth and in our fund we expect to deliver 6-7% growth per annum for the next two years.”