Core domestic property - and infrastructure - is in high demand among Belgian institutional investors, but they are facing the problem of increasingly low yields as a result. Gail Moss reports

Belgian institutional investors are renewing their interest in domestic real estate investment, driven by the need for stability and regular income from their investment portfolios - even if that income is more modest than they would like.

"Three or four years ago, the Belgian market was dominated by international investors which tended to pay more aggressively than locals," says Sheelam Chadha, associate director, investment at Savills Belux. "But those investors are now reassessing their European portfolios and are more affected by global economic shifts, while domestic investors - particularly Belgian institutional funds, such as insurers, pension funds and REITs [real estate investment trusts] - have taken the lion's share of investment activity."

Chadha says that domestic investors are, and always will be, attracted by stable returns, as well as Brussels' defensive qualities over the longer term. But the shortage of good quality real estate assets has changed pricing expectations.

"Eighteen months ago, investors could buy a long-term lease in a prime location at 6.25-6.5%," she says. "Today, it's closer to 5-5.25%. But with Belgian 10-year bonds now yielding around 4%, the difference still represents a good risk premium for domestic investors, in particular pension and insurance funds."

Chadha sees demand not only for offices, but also retail and residential, with particular interest in retirement housing on long-term leases, which is a new sector of interest for some Belgian investors as the office market is seen to be over-heating. However, they want longer leases - 10 years at least, but preferably 27 years.

In recent months, institutional activity in the Belgian property market has surged, posting €1.2bn worth of transactions in the first half of 2011, already more than for the whole of 2010. "However, with the potential fall-out from the debt problems of the US and the euro-zone, the second half of 2011 will be more difficult," Chadha warns.

The €1bn pension fund of Belgian banking and insurance group KBC is about to complete an extensive review of its strategic asset allocation, with final results expected by October. Its asset-liability management (ALM) study suggested that equities should be reduced by 10% to 40% as proportion of its overall portfolio. Pensioenfonds KBC's ‘real assets' portfolio is to be one of the beneficiaries of this move, with its target weighting moving up from 10% to 12.5%.

The increase will be used to boost direct and non-listed ‘real asset' holdings, including property, from 6% to 7-7.5%, and infrastructure from 2% to 3-3.5%. Listed real estate investments will also increase from 2% to 4%.

The pension fund is currently on the lookout for direct acquisitions of properties worth between €1m and €5m in Belgium. But Edwin Meysmans, managing director at Pensioenfonds KBC, complains of a lack of suitable supply in the market. "It is getting very difficult to find stock, because of competition from high net worth individuals," he says. "We're looking for a 5-6% yield, which is a fair price if you're getting indexed returns. But we don't want opportunistic plays at 8% or 9%."

All of the fund's direct holdings are in Belgium, mainly food-related supermarkets, which are seen as defensive, and offices.

The pension fund also owns two office buildings occupied by government departments under a sale-and-lease-back arrangement. KBC is looking for more properties to buy and lease back on 19 or 21-year terms, offering inflation-linked returns.

The pension fund is also looking for non-listed real estate funds, and planning to buy more in the coming months. "To us, listed real estate is not real estate, as there is too much correlation with equity markets," says Meysmans. "What we like about direct real estate is that the regulator recognises that its value will be more stable over time than stocks and shares. So it only has to be valued every five years, which creates more stability on our balance sheet."

Meanwhile, indirect holdings are in core and pan-European funds. "In selecting new funds, it is now back to basics," says Meysmans. "We now place more emphasis on yield rather than capital gains, and less leverage, and all our new investments are core or core-plus. We are defensive rather than opportunistic, even though that means a reduced yield."

According to Karel Stroobants, director, BVBA Kastro, and board member of OFP, the Belgian metalworkers' pension fund, the bigger pension funds are increasingly looking at indirect investments in infrastructure as a way of avoiding visible volatility.

"The good thing about quoted real estate is that you always know what the price is," he
says. "However, the drawback is the volatility of the equity market. Pension funds don't like that." Indirect investments are not so volatile because the price is not set daily, although Stroobants warns that investors still need to check values regularly to avoid nasty surprises over the long term.

Infrastructure is indeed the name of the game, agrees Manu Vandenbulcke, managing director at DG Infra+, which manages two infrastructure funds focusing on the Benelux countries and Belgium in particular.

DG Infra+ runs projects with development and construction risk, while DG Infra Yield is a lower-risk fund operating more mature, cash-generating assets, including renewable energy projects and public private partnership investments.

"It has taken a long time, but in the past 18 months we've seen an increase in the appetite of investors," says Vandenbulcke. "However, many first-time infrastructure investors are only putting a toe in the water, with either an infrastructure allocation limited to a small percentage of their total assets, or infrastructure included in their existing real estate allocation. They seem to like products providing them with annual yields."

But Vandenbulcke believes there is a large untapped potential out there. "We have recently seen some large-scale transactions happening with foreign pension funds, which makes Belgian long-term investors such as pension funds and insurance companies envious," he says. "Very often, it is to do with scale: only a few pension funds have more than €1bn to invest in total, so it is difficult for them to find big enough amounts to allocate to a single large infrastructure asset and not incur concentration risk in their portfolio."

Bigger investors, including insurance companies are, however, in a better position to invest than before, he says. "There is a large number of global infrastructure funds around, providing plenty of choice for large investors. However, today only a limited number of Belgian institutional investors have the size to make the kind of commitments that such funds require, hence the development of a market of more local alternatives."

Vandenbulcke says: "What these investors want is access to tangible assets, a cash flow, and alignment of the fee structure to yield." Some infrastructure funds have struggled to raise new money, he adds.

One sticking point, especially for smaller and first-time infrastructure investors, is the fee structure: "Many funds still use the classic private equity style of compensation structures," Vandenbulcke says. "But investors hate paying fees before any work has been done." By contrast, the DG Infra Yield fund charges a proportionate fee only when the investment generates cash flow.

Even outside the infrastructure sector, it seems that the Belgians are sticking close to home. For example, while OFP continues to invest in real estate on a pan-European basis, it has no plans to go global.

"We prefer markets where we have some local knowledge," says Stroobants. "And while most Belgian pension funds have exposure - albeit limited - to the UK, we prefer not to invest there because of the currency risk, and also because the British market is different from the European market."