GLOBAL - Income remains the dominant force in total return - but fund managers need to design structures that satisfy pension fund demands for real estate as a "bond with an extra yield", an IPD seminar audience heard yesterday.
LGP business development manager Dan Batterton attributed part of real estate's appeal to pension funds and insurers to its combination of debt and equity elements.
"Real estate acts more like an equity as lease events approach, but, up until then, it's also a bond with extra yield," he said.
"You can get 1.9% on a Tesco bond, but 260 basis points' extra yield on a Tesco sale-and-leaseback property.
"The problem is that there is a limited number of bond-like property assets. We need to design an income flow that exactly matches the demands of investors.
"There is still a need for normal, traditional real estate investments - but there's also a chance to create products that exactly meet an increasing need for liability-matching investments offering yield advantage."
As defined contribution pension funds overtake defined benefit schemes around 2020, Batterton forecast an increase in investor demand for access to different kinds of cash flow.
"Property needs to speak to other asset classes," he said. "The industry needs to look outwards."
Consultant Paul Mitchell distinguished between two different real estate income strategies: long-lease secure income and high income focused on yield.
Although high-income strategies potentially yield 200bps above the norm, they may include secondary assets and prime assets close to lease expiry.
In contrast, secure income strategies based on long leases offer "exceptional" performance over 10 years.
One challenge to income will come from a threefold fall in lease lengths over the past seven years.
That fall has coincided with a threefold increase in the length of rent-free periods as a percentage of total lease length.
Greg Mansell, head of research for the UK and Ireland at IPD, pointed out that, in contrast to the 1990s, when more than 40% of leases were renewed when occupiers exercised breaks, more than 50% of breaks in 2010 ended with a vacancy.
Although poorer-quality assets and those with shorter unexpired lease terms require more active management, Mansell suggested a wide range of median returns over the past 12 months might indicate well-managed secondary assets could outperform passively managed prime.
Mark Disney, head of shopping centre development and leasing at CBRE, said that, in some cases - notably in airports and train stations, and some factory outlets - short leases could be advantageous.
"Short leases are here to stay," he said, forecasting value changes in future would be driven largely by active management.
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