The world is changing drastically, so why should real estate portfolios stay the same? Robert Houston explains why UK pension funds are in need of fresh thinking

It's time for UK pension funds to re-examine their property portfolios. When Investment Property Databank (IPD) came onto the scene in the 1980s, it offered institutional investors their first glimpse of how their portfolios shaped up against their peers. IPD's service has been revolutionary and, most of all, it has brought credibility to what was a pretty dysfunctional sector.

I have nothing but praise for what Rupert Nabarro, Ian Cullen and the rest of their team have achieved. But I know they recognise their job is not yet finished. Not least, they need to find a solution for building up their exposure to the US, the world's largest real estate investment market.

After all, global investors need to feel confident there is consistency and integrity attached to their valuations and performance measurement wherever they invest. Currently, that is just not the case - and it needs to be.

The snag is that, for all the benefits of IPD, some investors have fallen into the trap of believing that balanced strategies need to (near enough) mirror the shape of the index. However, the world has changed. The UK has changed. Investment strategies that have been appropriate for the past 50 years (and now make up the index) are almost certainly past their ‘sell-by' date. After World War II, the UK rebuilt itself both economically and physically. Broadly speaking, we don't need any more offices, nor industrials, nor retail outlets. We have more than enough for the foreseeable future. Whether they are in exactly the right place, however, is another point.

On top of this, the demographic shape of the UK is changing dramatically.
The age pyramid to 2033 shows there will be some major bulges and pinch points in the coming years. For example, the 18-20-year-old cohort is projected to show no growth at all through to 2033, while the 65 years-plus group is expected to increase significantly. You don't have to be a rocket scientist to recognise that these changes alone are going to alter the dynamics of the UK economy. And property investors will need to react accordingly.

And what about our regional economies? Let's face it, pension funds have the vast majority of their property holdings outside London. The split is broadly 80-20. That doesn't feel right to me.

Surely investors should be investing in places that are growing. London most certainly is, yet quite a few regional markets are in retreat, and some are getting horribly close to the cliff edge. With this in mind I would predict that those investors intent on ‘hugging' the existing IPD All Property index as a benchmark will come a cropper, and quite quickly too.

So what to do? I would ask them to seriously address four important areas: one, global investment; two, a higher weighting towards London; three, a reassessment of the sustainability of some of the regional markets; and four, a meaningful exposure to the residential sector.

None of these sound overly dramatic on their own but, in total, they amount to a radical repositioning away from the IPD benchmark. Here's why:

Going global:
urban population growth in Asia and North America is predicted to grow by 63% and 28%, respectively, by 2030. The comparable figure for Europe is 8%. Surely the best place for investment is where demand is strongest; investing in the main overseas markets is no longer a minefield. There are well-trodden paths to follow, and the leading firms of investment advisers, lawyers, valuers, tax advisers and IPD are all there; it can be done. In 1970 only 4% of UK pension funds' equity portfolios were invested in overseas shares. It is now 54%. Why? Because investors have recognised that is where the growth is.

London weighting: London is St Bride's number-one world city. Our world city model is a risk-management tool designed to identify the most secure destinations for long-term investment. It is based around constitution, business environment, economy, knowledge, access and infrastructure, quality of living and, of course, depth and transparency of the property market; London's population is predicted to grow by 20% from 7.5m to 9m by 2031 - a key growth driver; in order to accommodate this growth, the shape of London will continue to evolve into a poly-centric city. Occupiers and investors will become much less fixated by the Mayfair-City axis, opening up new opportunities in the emerging locations around Farringdon, King's Cross, Waterloo, etc.

Regional stability:
It is about time we all stop rabbiting on about the UK's north-south divide. To a large measure, it is a fallacy. There are plenty of excellent investable locations outside the South East. The challenge, though, is to separate out the wheat from the chaff. Unfortunately, many investors do not yet seem to have got around to it, and I am afraid they will pay the consequences; Edinburgh tops the St Bride's UK long-term sustainable cities league table. In fact, no less than 18 of the top 30 cities in our research study (65 cities over 100,000 population) are located outside the South East and definitely worthy of investment consideration, albeit at the right time in the cycle; even so, it is hard to recommend a higher portfolio weighting than 50/50 for regions versus London, which is radically different to the IPD benchmark.

Residential: Most other ‘grown-up' countries around the world have a significant institutional residential investment market. The IPD global average is 13%, with some countries like Switzerland and the Netherlands having nearly 50%. The UK weighting is just 1%; the UK is facing a growing housing crisis, with an estimated shortfall of 750,000 homes by 2025, in no short measure due to the predicted growth of an extra 4.5m people by 2018; residential has significantly outperformed the main commercial sectors over the past three, five, 10 and 30 years, and it looks as if it will continue to do so, as demand is set to continue to exceed supply - by some measure; and if it is the (relatively) low-income returns from the private rented sector that is putting off investors, then blending a range of different types of residential investments can push up the overall yield, and generate noticeably longer lease commitments.

So what is stopping our UK pension funds from embracing these changes? True, divestment/investment will be expensive, but this will pale into insignificance compared with the cost of underperformance.

It is time for some fresh thinking. Let us hope that common sense and wisdom prevails.