The average real estate allocation of German institutional investors is set to rise to 7.5% by 2011, according to a new survey by Feri. Helmut Knepel examines the results in detail

During times of turmoil on the capital markets, institutional investors tend to incline more toward low-risk investments marked by stable returns. Like others before it, the ongoing financial crisis has severely impacted the asset allocation of institutional investors, as a recent survey by Feri Eurorating Services AG suggests.

Conducted biannually to poll the real estate affinity of about 150 major German investors, this Feri survey documents that the willingness among investors to raise their real estate ratio has been growing since the beginning of the year. While the percentage of those who wished to increase their investment share in real estate stood at 40% as late as March 2008, the figure rose to 46% by June, reaching 50% in September and remaining at 49% in December.

The reasons quoted to explain this trend were, above all, the expectation of stable returns due to low fluctuations in value, a better diversification in the overall investments, and a low correlation to stocks and bonds. The real estate ratio is expected to rise from currently 7% to 7.5% by 2011. The investor groups planning the highest increases are insurance companies and superannuation schemes.

The Real Estate 2008 Feri survey represents a market coverage of 75%, measured against the total investment volume of the top 50 investors in each investor category. The total investment volume of all institutional investors polled equals approximately €1trn.

Of this sum, approximately €70bn represents real estate assets. This translates into a present real estate ratio among German institutional investors of about 7%. While that figure still stood at 6.1% in 2004, it already equalled 6.6% in 2006.

Of the real estate assets belonging to the polled institutional investors, the largest share of 58% are held by insurance companies. Retirement funds account for another 33%. The share of banks represents 6%. The remaining 3% is held by foundations, churches and industrial firms.

Traditionally, banks have had the lowest real estate ratio. Their portfolios consist primarily of owner-occupied properties. As floor space becomes redundant due to branch closures, banks will expand their real estate ratio only slightly, from 4.1% today to 4.5% by 2011. Insurance companies, while yet remaining below the general average with a real estate quota of 5.1%, are planning a hefty increase by one percentage point before 2011.

Superannuation schemes already report a relatively high real estate ratio of 9.4%, and intend to raise it further by nearly one percentage point. The real estate ratio of industrial investors will go up from 14.1% to 15.1%, yet this increase is primarily explained by a reduction of the securities share.

In the implementation of the plans to raise the real estate ratio, each group of institutional investors pursues its own approach, sometimes with big differences between them. Nearly 71% of the superannuation schemes are intending to step up their real estate investments.

As far as banks are concerned, 78% prefer to maintain their present ratio. Insurance companies follow the general trend: 45% wish to raise their real estate share; 36% plan to keep it unchanged, and the rest would like to lower the ratio. The financial crisis has also influenced the risk exposure of institutional investors within the investment category of real estate.

Core investments account for a 76% share of the real estate assets. Opportunistic investments, by contrast, are altogether negligible at less than 1% (as recently as two years ago, their share amounted to nearly 6%). At 19%, core-plus investments remain clearly ahead of the riskier value-added investments, which represent 4%.

Meanwhile, the trend toward indirect real estate investment vehicles remains unchecked. While the stock and bond investment ratio of externally managed portfolios will see no changes at 87% and 55%, respectively, it is safe to assume that indirect real estate investments will go up by about nine percentage points to roughly 52% by the end of 2011.

Investors associate the indirect real estate investments with a higher profitability, a greater diversification in the real estate portfolio, and a reliance on expert know-how on the part of the hired real estate asset managers. Therefore it comes as no surprise that the share in owner and tenant-occupied direct real estate investments has dropped to 57%, that is, down by 10 percentage points since 2006.

The biggest winners of this development were specialised funds, whose share increased by 5.1 percentage points. Closed-ended funds (+3.6 percentage points) and mutual funds for institutional investors (+2.6 percentage points) also benefited from the trend toward indirect real estate investments.

Then as now, institutional investors disregard the vehicles of real estate stock and real estate investment trusts as investment options. Then again, there are signs suggesting that SICAVs (societe d'investissement a capitale variable) and FCPs (fonds commun de placement) will gain in importance in the years to come.

Compared with 2006 levels, these investment forms made very modest gains of just 0.1 percentage points. There is reason to expect SICAVs and FCPs to increase by 2.6 percentage points, though, before the end of 2011. Closed-ended funds and special funds (spezialfonds) will show a very similar increase. Owner and tenant-occupied direct investments will decline by another nine percentage points and thereby continue their negative trend.

At nearly 40%, superannuation schemes commit the highest share of their real estate investments in the form of specialised funds. Insurance companies show a share of 23%, whereas banks report a share of just 10%. Closed-ended funds show a different picture: this vehicle is favoured as the real estate investment of choice by industrial investors (24%) and insurance companies (12%) more than by any other institutional investor group. With superannuation schemes, the ratio barely amounts to 4%.

On the whole, 27% of the investors maintain commitments in closed-ended funds, with another 13% being principally interested in this investment vehicle. In terms of geographic allocation, major investors in Germany have increasingly focused on real estate hubs. The latter's share has risen by 11.2 percentage points since 2006.

Regional economic hubs, by comparison, have fallen out of favour and lost 14 percentage points. Also very much in demand were western European markets other than Germany. More than half of all investors remain unwilling to commit themselves to the Asian-Pacific region just yet.

However, 22% of them consider investments in established real estate markets such as Japan, Australia, Singapore or Hong Kong an option. As far as type of use, the focus is clearly on offices: compared with 2006, the office share rose from 43% to 58% in 2008. Aside from offices, the retail sector was one of the winners: over the past two years, the retail share rose by 5.8 percentage points to 13%.

Sustainability of real estate investments appears to be less of an issue for institutional investors than one might expect. It is true that 48% attach major importance to the subject, but at the same time it is deemed rather negligible by 39%, and is actually irrelevant for nearly 13%.

Looking ahead, about 34% of all investors will take the sustainability of investments in real estate into account, whereas 22% will address the subject neither today nor tomorrow. If nothing else, 44% will at least consider the subject at some point.

For nearly 46% of all investors the observance of corporate governance is an essential criterion when selecting an asset manager. In the securities sector, this factor matters only to 41%. However, even though the subject is taken very seriously, investors feel that just 18% of all asset managers have fully lived up to their corporate governance code.

Helmut Knepel
is CEO of Feri
EuroRating Services AG