The listed property debate has moved on, but is the industry ready to mix REITs with private real estate investments? Richard Lowe explores.

The public-versus-private real estate debate has been rolling on for years. Argument A: Listed investments are too volatile, highly correlated with the wider equity markets and, in fundamental terms, not real estate. Argument B: Listed investments provide an effective proxy for the underlying real estate market over the long term at a much lower cost, and their short-term volatility can be ignored if investors are truly long-term in their approach.

Such polarised thinking seems to be giving way to a more nuanced discussion. There is growing consensus that both approaches have their merits and the optimum solution would be to combine them. Some institutional investors, such as Dutch asset managers APG and PGGM, do just that, often citing the ability to adjust according to market cycles and take advantage of arbitrage opportunities along the way.

The European Public Real Estate Association (EPRA) has sought to act as a catalyst in this debate, long ago realising the best way to attract greater institutional investment in the listed property sector was to promote the blended philosophy rather than attempt to supplant the private real estate market entirely.

During its annual conference in Berlin, EPRA helped launch a body of research. This included a study from Maastricht University that analysed data from global pension fund real estate investments over the past two decades, and concluded - albeit very generally - that pension funds would have enjoyed better performance and lower costs had they invested more in listed real estate.

The non-listed fund-of-funds approach came under the greatest criticism due to its high costs and underperformance (again, on average), which combined to erode net returns to investors. US pension funds, in particular, were shown to have suffered the most because they relied heavily on real estate consultants to invest in private real estate vehicles on their behalf.

One factor the study does not take into account is that the European property multi-manager is evolving. The likes of CBRE Global Investors’ multi-manager arm, the Townsend Group’s European business and Composition Capital are today looking beyond just investing in real estate funds and targeting wider opportunities like more direct joint ventures.

William Hill, head of property at Schroders, terms this “multi-manager 2.0” and says multi-managers are effectively taking over the ground that used to be the reserve of the opportunity funds, backing local operators directly. How the investment performance of this approach will compare with the traditional fund-of-funds format is yet to be captured.

Hill also describes a “multi-manager 3.0” concept, where the manager would invest not only across non-listed opportunities but also listed ones. His thoughts may have something to do with the ongoing competition between multi-managers such as Schroder Property and investment consultants like Mercer and Towers Watson - the latter often seek to differentiate themselves by their ‘agnostic’ approach to investment advice. Towers Watson, for instance, has been discussing with investors in recent months about the potential to invest in Asian REITs.

Fund management houses like Schroders have dedicated listed real estate businesses and so in theory are well placed to provide investment solutions that blend private and public real estate strategies.

But another important piece of research being undertaken on behalf of EPRA is exploring the issues that are potentially inhibiting institutional investors from effectively blending listed and non-listed real estate. A pilot survey designed and undertaken by real estate consultant and professor Andrew Baum, Alex Moss of Macquarie Securities and EPRA’s research director Fraser Hughes discovered that many real estate fund managers were not set up in a way to integrate their private and listed real estate investments.

The survey also found a mismatch between what some investors sought from REIT investments and the approach employed by REIT fund managers. For instance, one survey respondent said: “The REIT allocation is actively managed against an EPRA benchmark … but it is there to create a real estate-linked liquidity buffer, so why trade it?”

Baum says the pilot survey will be followed up by more comprehensive research. “The pilot has suggested that the majority of asset managers have not developed a satisfactory integrated investment process,” he says. “As asset managers develop their product ranges to meet what might be a rising demand, they need to solve the investment process problems of integrating listed and private real estate within one business and one portfolio.

“In particular, they need to be able to show the listed portfolio is being managed with an eye on the strategic objectives of the real estate allocation, and not on a standard solution that suits the objectives of the listed real estate team, often separated from the real estate desk.”