UK - Pension funds should target long-lease assets such as supermarkets and social housing to lower the risk of investing in the marginally overpriced UK property market, according to Aberdeen Asset Management.
In a report published this week, the fund manager said investors should be targeting assets with 20-year lease terms - compared with average lease lengths of 5.8 years - and strong covenants.
The report claimed leases of up to 30 years, competition for space and outperformance during downturns made supermarkets "exceptionally low risk" and the "most favoured investment option" despite unfavourable entry pricing and low yields.
Property research director John Danes also pointed to long-leased, low-yielding social infrastructure assets tied to strong covenants. Unlike illiquid pure infrastructure assets, social infrastructure assets - including student housing, prisons and medical practices - more closely resembled real estate, he said.
Demand for under-supplied social housing made the asset sub-class "one of the more interesting and potentially most secure emerging markets", according to the report. However, despite the sector's scale, it is relatively inaccessible to direct investors, with limited investment opportunities.
Across all three categories, Danes warned against risks including weak covenants and over-renting, which ruled out passive approaches to investing.
"Investors simply cannot assume that successful long-let Investment is passive buy-and-hold strategy," he said.
The report acknowledged that real estate sectors with long-lease potential were in some cases "small and nascent", and therefore unpredictable. However, it claimed long-lease assets - especially supermarkets - offered "bond-like" characteristics with higher returns.
"Property assets with long leases and secure tenants should prove attractive to pension fund investors given the low levels of rental volatility and minimal void risk which provide for stable, secure and predictable income returns," said the report.
Although it acknowledged that long-term holds carried lower yields than shorter-income assets with weaker tenants, Danes said likely continuing low bond yields made sharp upward pressure on property yields unlikely in the short-to-medium term.
"The prospect of strong rental growth looks unlikely given the weakness of the economic outlook," he added.
