The move from DB to DC pension schemes holds mixed blessings for real estate, while the crisis has focused minds on risk, as Gail Moss reports

Italy has a sizeable and more sophisticated institutional investor community, compared with the rest of southern Europe.

"While countries such as Portugal and Greece are dominated by life and pension funds investing locally, Italy has a much more diverse investor base," says Sabina Kalyan ay European head of research, CB Richard Ellis.

Major players include the Unicredit banking group pension scheme, and Pirelli Real Estate (recently renamed Prelios), the investment arm of Pirelli, which continue to be active.

But it is not only local investors who are making the running. Overseas institutions, which had pulled out after Lehman's collapse in 2008, are now returning.

"We are starting to see foreign institutional investors such as Allianz come back in," says Kalyan. "But they are only going for safe haven assets, such as prime, regionally dominant shopping centres. These can provide a secure income, provided they are leased up. And there will always be the potential to trade out of a recession."

She says that institutional investors are focusing not so much on Italy as a whole, but on Milan, one of the most affluent, most productive regions in Europe. This region is still likely to enjoy investor confidence whatever happens elsewhere, she believes.

Real estate investing by Italian pension funds is strictly regulated. Funds which existed before 1993 are mostly defined benefit schemes, and are now all closed to new members. The pension fund legislation of 1993 allowed new, contractual defined contribution pension funds to be set up in their place.

Pre-existing pension funds can own real estate directly and purchase shares in real estate closed funds, while contractual pension funds can only purchase shares in real estate closed funds.

This has forced a gradual divestment strategy for the pre-existing funds, according to Piero Marchettini, managing partner at Adelaide Consulting. "These pension funds still own a significant amount of real estate in direct investments, which, for the 10 largest funds, is about one-third of their assets," he says. "But they are reducing their exposure because, while no new members have joined since 1993, they must still pay pensions to their existing pensioners and members. And real estate is not liquid enough to achieve that."

The Pension Funds Supervisory Authority (COVIP) has recommended that by May 2012, these funds should hold no more than 20% of their assets in real estate.

"The contractual pension funds are, however, seriously considering investment in real estate funds in order to diversify their asset allocation and improve their overall performance," says Marchettini. "Since 2000, the overall return of these pension funds has been of the order of only 30%, less than 3% per year. In contrast, real estate has performed much better than other asset classes."

And he suggests that beneficiaries of this new influx of money are likely to include the infrastructure funds currently being launched to fund Italy's extensive public works programme.

"Some of the most active institutional investors in real estate have been the cassa [long-established pension funds for self-employed professionals, such as doctors and lawyers]," says Armando Piccinno, senior associate of Mercer Italy. "The stock market in Italy is relatively small and has been plagued by a series of difficulties, leaving shareholders suspicious and reluctant to invest. That has given pension fund investors in Italy a renewed interest in the real estate market."

Piccinno points to a trend for pension schemes to move from direct to indirect real estate, through closed-ended property funds managed by real estate companies. Some vehicles are set up between an individual pension fund and a real estate company, while others are split between several shareholders. And some cassa shift their directly-owned property into a fund vehicle, in exchange for shares.

Typical of the continuing activity on the indirect front is the planned new fund from Torre SGR, the real estate asset management company controlled by Fortress Investment Group and Pioneer Investments.

The fund, expected to be launched by this year, will target qualified institutional investors only and will be composed of two sub-funds in order to exploit simultaneously the momentum in the two different real estate investment profiles.

Another route to property exposure, which Mercer believes will become increasingly relevant to pension funds, is investing in real estate investment trusts (REITs).

But Piccinno does not see Italian institutions necessarily sticking rigidly to their home market. "While they prefer to invest domestically because they understand the drivers of the local real estate market better than the international market, this focus will become less dominant as long as they consider real estate to be a bona fide asset class," he says. "A number of our clients are now looking at property within the wider euro-zone as a way to increase diversification."

However, Gianluca Muzzi, head of Europe ex-Germany for RREEF, is more cautious. He says that pension funds are not presently prepared to acquire a significant exposure to international markets, although some have taken an interest in the US because they believe it to be underpriced.

"Meanwhile, within Italy, they are core investors, so it is the office sector which attracts them most," he says. "I don't see them getting a significant exposure to retail, which requires intensive asset management. And the residential sector gives too low a yield - between 1-3%, compared with around 6% for offices."

Investment tends to be concentrated on the major Italian cities, with many pension funds owning their own office buildings.

"There is a heavy exposure to the Rome market - partly because that is where most pension funds are based - with some exposure to Milan," says Muzzi. "It will take years for them to start looking at secondary locations."

Meanwhile, Italy's economic problems have meant that attention has been directed back to minimising risk rather than maximising returns. "Before the crisis, even the traditional pension funds were looking at the possibility of sophisticated transactions," Muzzi says. "But the crisis has made them go back to basics, focusing particularly on the domestic market, which they know better, and which is less competitive. They are concentrating on solid tenants with secure sources of income, rather than betting on the market continuing to improve."

But he says that pension funds are increasing their level of professionalism by doing deals with foreign institutional investors, a trend which he expects to speed up.

Looking to the future, Kalyan does not consider the country's economic problems to be a threat to property investment.

"Italy is a serial offender in terms of public debt," she says. "But it has the most liquid bond market after the US and UK, so financing the debt isn't such a big deal. Though the country has problems, they are no different from those of five years ago. So there is a feeling that it can sort things out."