The recent claim by Andrew Chapman, John Lewis pension scheme's investment manager, that no scheme wanted to be exposed to reputational risks such as tenant evictions, and the solution would be to separate investment and asset management "so we weren't held responsible in that way", amounted to a request for risk removal. But is he looking at the wrong risks.
The risk associated with evicting individuals has been held up for decades as one of the primary reasons why UK pension funds have been reluctant to invest in housing. But their mainland European counterparts clearly do not have the same reservations. Tony Key, professor of real estate economics at Cass Business School, points out that residential makes up 40% of Dutch and 60% of Swiss investors' property portfolios.
Nor does it explain strong institutional investor appetite, including in the UK, for sub-sectors such as nursing homes - which come with as much if not more potential reputational risk.
Key suggests residential should make up 40% of the optimal property portfolio - not least because office has an unattractive risk/return profile despite making up the greater part of the average portfolio. Housing has much going for it, including: a large and diverse tenant pool; the fact income makes up a relatively stable part of the return; low volatility; long-term rental income growth; and long-term capital growth (the latter both correlated with wage inflation).
It is just that it has plenty detracting from it as well - including a nominal percentage income yield that will always be lower than for commercial. Add to that high management costs - though not as high as investors believe them to be, according to Mark Weedon, head of residential at Investment Property Databank (IPD). Typically, residential retains 65% of net income after costs and commercial 80%, but investors tend to believe commercial delivers more than 90%. Residential also (sometimes) has capital growth behind it. Strip away the old connotations - tenant risk and a fragmented market - and the problem is that investors simply cannot source the assets. "The biggest issue for investors is the lack of suitable investment opportunities - units of suitable scale, age and quality," says Weedon.
Unlike Weedon, Key sees product unavailability pretty much as an insurmountable market barrier because policymakers are unlikely to implement sufficiently radical measures to allow residential bulk-building. "If you could buy chunky residential blocks - like mansion blocks in central London - just as you might in Germany or Sweden, investors would do it," said Key.
The problem is not the tenants or the likelihood of default but the fact that, to buy it, they would have to build it. Elsewhere in Europe, that is not out of the question, of course. In Denmark, PFA pension fund has invested in development projects, including the old Carlsberg brewery site, specifically because of a forecast increase in demand for Copenhagen housing. This week, an unidentified German pension scheme was announced as a €100m co-investor in a Patrizia fund targeting value-added and residential development projects. In the UK, by contrast, developers can recycle capital more quickly if they sell assets individually off-plan.
So pension funds are holding off. The Newham local authority pension scheme, reported last September to be backing a shared-ownership residential vehicle set up by the Mill Group, did not in the end. "Newham Council pension fund has not invested in housing," Alec Kellaway, chair of the authority's investment committee, said. "The pension fund might very well do so, subject to the usual professional advice, but no action has been taken yet."
Two new residential institutional funds have been launched by Grainger and Cordea Savills respectively. Their success in the capital raising market will be a test for pension fund appetite.