New research uncovers the composition and returns of Dutch institutional portfolios. Marco Mosselman and Simon van der Gaast investigate
In 2013, IVBN, the association of institutional property investors in The Netherlands, carried out research to gain new insights into the composition, risks and returns of institutional real estate portfolios. There is regular debate about risk and return of this public capital, but what is actually known about the composition and returns of the real estate portfolios? With this in mind, the research focused on data from the investment portfolios themselves instead of index data.
With 38 investors, the total real estate investments amounted to €92.8bn (in 2011). The research covers 32 pension funds and six insurers. Figure 1 shows the division between direct investments in ‘bricks’, indirect public (listed) real estate, and participations in (non-listed) real estate funds. At the end of 2011, direct investments accounted for, on average, 27.8% of the portfolios, non-listed indirect real estate 43.9%, and listed real estate 28.3%.
It was possible to divide the real estate exposure by regions for 27 of the investors, accounting for €73.6bn: 37% Dutch real estate; 23% other European; 26% North American; 14% Asian. The same could be done for sectors for 25 of the investors, accounting for €72.4bn: 26% in residential; 27% retail; 15% offices; 5% industrial and logistics; 27% in mixed funds or other real estate.
For 28 institutional investors, at least 10 total annual returns were retrieved. These are shown in figure 2.
Calculating the average return for the total group of investors led to an unweighted average total return of 7.5% over the period 2000-12. This figure weighs each real estate strategy equally and therefore does not take into account the size of the real estate portfolio. The weighted average total return is 9.2%. This figure does take into account the volume of the real estate investments.
There appear to be large differences in the data set between the (unweighted average) returns of the various investment methods. Figure 3 shows that in the period 2001-12 direct real estate realised the lowest returns (average 5.8%), but also the most stable (the standard deviation was 4.8%), and achieved the most favourable Sharpe ratio (0.63).
Direct real estate was followed by non-listed indirect real estate with an average return of 6.3% with a standard deviation of 7.2% and a Sharpe ratio of 0.49. Finally, listed real estate showed a return of 10.1% with a standard deviation of 24.6% and a Sharpe ratio of 0.30.
With an average return of 5.6% over the period 2002-12, a standard deviation on the return of 4.5% and a Sharpe ratio of 0.65, the risk-corrected return of Dutch real estate compares favourably with alternatives in other European countries (average return of 6.1%, standard deviation of 14.6%, and a Sharpe ratio of 0.24); North America (average return of 3.9%, standard deviation of 17.8%, and a Sharpe ratio of 0.07); and Asia (average return of 7.1%, standard deviation of 16.1%, and 0.28 Sharpe ratio).
There are three possible explanations for the attractive risk-corrected return on Dutch real estate. First, Dutch investors know their home markets better. Second, the Dutch real estate market is relatively small, and investors therefore demand an illiquidity premium. Third, the composition of Dutch portfolios is different to those of foreign ones (for example, fewer trophy buildings). And, more than average, Dutch real estate is owned in the form of direct investment in ‘bricks’. This means that the return is relatively stable, which translates into low volatility and low risk. The higher volatility of foreign real estate then results from the fact that this real estate is mainly owned in the form of indirect investments, which have a more volatile nature.
The research also showed some differences in returns by sector. ‘Other’ segments led to the most volatile returns, while the residential sector led to less stable returns than the retail sector. The highest returns, the lowest risk, and (therefore) the most attractive Sharpe ratio (1.40) were realised by retail investments. Industrial and logistics real estate investments, on the other hand, showed a low return and high risk.
The composition of large institutional real estate portfolios differs substantially, due to the fact that each investor follows its own unique strategy, based on future obligations, risk preference, investment beliefs etc. However, we also noticed a number of similarities between the portfolios. For example, one group of investors mainly invest in direct real estate. In addition, there are several investors that have a relatively large proportion of residential investments in their real estate portfolios.
By means of a statistical cluster analysis, four archetypes of real estate strategies were distinguished in the real estate portfolios:
• Strongly diversified investors with large mandates and diversification across all dimensions;
• Real estate specialists with a home bias that particularly own direct Dutch real estate;
• Diversified fund investors that invest in real estate funds and divide their investments 50/50 between private and public funds;
• Private fund investors that mainly invest in non-listed real estate funds.
The strategies have led to different returns. With hindsight, it turns out that the first strategy resulted in the highest returns, which is mainly due to the high returns on foreign listed real estate. Because the returns of these listed investments also come with a relatively high volatility, the funds adopting this strategy also ran the highest risks.
Marco Mosselman is senior account manager at Syntrus Achmea real estate and finance, and Simon van der Gaast is senior policy adviser at IVBN
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