The UK is the exception when it comes to institutional investment in housing. Rachel Fixsen talks to six European pension funds about the merits of residential

Hermann Aukamp
NAEV
*German Pension fund targets modern, energy-efficient stock
*Residential assets in Germany with indirect exposure in US
*Value increases seen in major German cities over past 2-3 years

Major German cities have become the focus for residential property investment at Nordrheinische Ärzteversorgung (NAEV), which targets mid-market, modern buildings with good energy credentials.

"Ten years ago we sold a lot of our housing in Germany that was not up to standard in terms of location and quality of the buildings. But at the same time we were starting to concentrate on major cities: Hamburg, Cologne, Düsseldorf, Berlin, Munich and Frankfurt," says Hermann Aukamp, director of property investment at NAEV, the pension fund for doctors in Germany's North Rhine region.

"These markets have been the best performing in the last two to three years," he says. "The demographic situation is good; we concentrate on the mid-market, not the high end."

NAEV has 11% of its €10bn total assets invested in property, and within that, a 30-35% allocation to residential. Most of this is in German property, with a small proportion - less than 2% - in residential property funds in the US and Canada. "The running yield is lower compared to commercial real estate," Aukamp says.

"We only invest in new residential buildings that are up to the latest standards in energy, etc., so it's not possible to compete with office when it comes to running yield." The long-term outlook for residential in Germany is very promising. "The overall risk return is quite interesting. It's not as volatile as commercial real estate, and letting levels are more or less 100% in Germany," he says.

Tenancy contracts in Germany run for much longer terms than contracts in the UK, for example, and the proportion of owner-occupiers is much lower in Germany. "Even in this situation where interest rates are lower, and it's much easier to finance a condo, people prefer to rent," he says.

Residential values have continued to rise in Munich and Hamburg and to a certain extent in Düsseldorf, Cologne and Frankfurt. "There is a lack of new product in the cities," Aukamp explains. "People want modern stock that is energy efficient and of a good quality."

Guido Verhoef
PGGM
*Residential brings a stable element to Dutch investor's portfolio
*European investments confined to Netherlands and Germany
*Recent entry into the Asian market through development projects

For Dutch pension fund service provider PGGM, the residential sector is a bulwark against storms in the commercial property market. Guido Verhoef, head of private real estate at PGGM, says: "We like the risk-return profile of residential; it is a defensive sector. It brings a stable element into the portfolio."

He adds: "It is normally indexed on a yearly basis to inflation, and there is usually - but not always - some value growth."

The way residential portfolios are structured makes them very diversified: in location and number and duration of rental contracts. Therefore, residential investments add value to a pure commercial portfolio, Verhoef says.

PGGM holds between 10% and 15% of its €105bn total assets in listed and non-listed property. Verhoef looks after the €7bn non-listed portion, of which 20% is allocated to residential. However, PGGM also has exposure to residential through its listed property investments.

All private property investment - including residential - is done indirectly via non-listed funds and joint ventures. Returns may tend to be lower than those for commercial property, but volatility is also limited. "We have the proof in our own portfolio that it's a super-stable bet," he says.

"It's labour-intensive, but if you've got the right manager, it works smoothly. If you compare it with retail investments, though, there is not a lot of difference in terms of the management required."

PGGM's residential holdings in Europe are confined to the Netherlands and Germany. "Outside the Netherlands and Germany, it's pretty hard to find this type of asset in volumes big enough to be interesting to our institution," he observes. The US holdings are more volatile than the European assets, but they are interesting for diversification reasons.

In the past two years the institution has entered the residential markets in India and China. "We are involved in development schemes there, but these are self-liquidating assets," he says, adding that between 60% and 70% of the units are pre-sold when construction starts.

As yet, Verhoef says there are not enough mid-market rental opportunities to tempt PGGM into longer-term residential investments in Asia.

Alan Layton
Islington Pension Fund
*UK pension fund trialled residential exposure via co-investment fund
*Caution surrounding a lack of track record
*Rationale to diversify portfolio

Investing in housing is a rare activity among UK pension funds, although rental yields continue to rise steadily. With mortgage finance often hard to get, many would-be buyers are being forced into the lettings market.

But UK pension funds appear reluctant to dip a toe in the investment sector. "All pension funds are very nervous about getting involved in an area where there's no track record," says Alan Layton, service director for financial management at Islington Council in London.

When the fund considered the sector, they looked for tried-and-tested vehicles. "We wanted something robust and fairly low risk," Layton says.

The fund has now tentatively committed £10m of its £750m in total assets to the Investors in Housing Fund, run by the Mill Group.

In the UK, house prices are so high in many areas that individuals have trouble raising the required deposit for a mortgage. The Investors in Housing Fund is a co-investment vehicle giving such people access to the homes market. The individual buys 5% of the property and the fund buys the remaining 95%, on which they pay rent to the fund. The idea is that after five years, the buyer is able to raise a 90% mortgage on the entire property.

The fund says it will invest in "good quality residential property", initially in Greater London and the South East. Rental returns are delivered from long-term contracted arrangements under which occupiers bear maintenance and insurance costs.
Layton says the fund has considered the idea and is now doing due diligence on the fund.

"We've diversified more into commercial property in the past year or so, and we've reduced our equity holdings. This would provide further diversification for us."

Although the investment is seen as beneficial to the fund in terms of spreading investment risks across different asset classes, there are still concerns, Layton stresses. "Part of the risk we have to consider with residential property is, what happens if it loses its value," he says.

Tomas Svensson
AP1
*Rental levels in Sweden have negligible supply risks
*Portfolio vacancy rate of less than 0.7%
*Risks around mismanagement and negative publicity

There are three reasons why investing in residential property makes sense for AP1, the first of five buffer funds for Sweden's PAYG pension system.

"Historically a stable investment, it offers relatively good inflation hedges due to the rental structure and it complements the rest of the fund's assets," says Tomas Svensson, portfolio manager
for real estate at the fund.

At the end of June 2011, AP1 held around 5% of its SEK222bn (€25.1bn) of assets in property. "We have allocated around 1.3% of the total fund capital to residential real estate, as at the end of June 2011. This corresponds to approximately a quarter of our property holdings," Svensson says.

While residential risks are common to many countries, the Swedish market is different, he explains. "As the rental levels in Sweden have a very limited supply-driven market rent component and merely grow with inflation, or slightly above, the main risks are essentially on the cost side.

"Furthermore, the replacement costs for rental flats are far greater than the property values in most Swedish cities, which is why the risk of over-supply is virtually non-existent," he says.

"We have a vacancy rate of less than 0.7% in our portfolio, which is hard for a foreign investor not knowing the local market dynamics to understand."

AP1's exposure to residential is achieved through it's wholly-owned subsidiary Willhem, which manages some 11,500 rental apartments in seven Swedish cities.

Market risks aside, there is a certain administrative burden involved in owning housing. "As well as this, there is the risk of negative publicity in case of mismanagement. This is why we have chosen to control this by having our own staff at Willhem who provide all the services internally."

Svensson says AP1 will continue investing in the residential sector, mainly by expanding its unit at Willhem. "But we might also invest in the sector by participating in a club or joint venture in a new market," he adds.

Michael Willumsen
PFA
*Danish pension fund sold out of residential
*Sector overheated in 2006 and turning point yet to emerge
*Investments made in two development sites in Greater Copenhagen

While residential property plays an important role for some Nordic pension funds, Denmark's PFA has been more than willing to stay out of the sector completely during a prolonged phase of market weakness.

Before 2006, the fund was heavily involved in residential, Michael Willumsen, head of property investment at PFA explains. "We sold all our residential property in 2006, selling 2,200 units to RREEF, a Deutsche Bank AG fund, for DKK4bn," he says.

"Back in 2006, the market was extremely overheated," Willumsen says. "It is very hard to see when the turning point is. Like the rest of Europe, the Danish residential market is pretty depressed if you want to sell. The lettings market is doing reasonably well, but even though demand for residential is increasing at a firm rate, it is not there yet."
Right now, returns on residential are hovering around the 4% mark, he says.

Once the market is right, though, PFA will reconsider its position. The pension fund has invested in two development sites within Greater Copenhagen, which could come to fruition in terms of making a first investment commitment in 2014 at the earliest.
The development sites are Carlsbergbyen in Valby - the site of the old Carlsberg brewery - and Refshaleoen on the other side of the harbour overlooking central Copenhagen. Carlsbergbyen has already received permission to start development. The development of Refshaleoen is expected to start around 2020.

"Copenhagen's population is expanding," Willumsen notes. "An inflow of between 10,000 to 12,000 people (each year) is expected for the foreseeable future, meaning there will be a natural take up of 3,000 to 5,000 residential units a year. So the bottom driver in the market seems to be in place."

The Carlsbergbyen project includes permission for 2,500-3,000 residential units. "We expect that around 50% of each development could be residential, one of the main reasons for PFA joining. This will be a potential pipeline of both residential and commercial for PFA to invest in," he says.

Reto Schär
Migros-Pensionskasse
*Three-quarters of property portfolio in directly held residential assets
*Sector resistant to economic swings an advantage
*Domestic market in Switzerland overheated

The pension fund of Swiss retailer Migros - the Migros-Pensionskasse - has close to CHF16.86bn in assets under management. A total of CHF4.3bn is invested in real estate, with 75% of that held in residential property assets. All of the pension fund's residential property assets are held directly.

Maintaining such a high proportion in residential is fairly typical of a Swiss pension fund, according to the fund's head of property investment Reto Schär.

"Residential property has the advantage of being resistant to the prevailing economic conditions," he says. "People always need to live somewhere. By contrast, there are many risks involved in investing in commercial property. These are primarily economic and commercial; it is not always possible to get business properties fully rented out."

Even though tenancy in the residential property sector is affected by periods of economic weakness, the impact is not as great as that felt in the commercial and office building market, he says.

Comparing residential to commercial property, Schär says homes produce a slightly higher yield for the investor, but this does not come at the expense of a correspondingly higher level of risk.

He notes: "There are not so many good potential investments in the residential sector now; the market has become rather overheated. Demand for suitable properties is much higher than supply."

Looking ahead, Schär sees good prospects for residential as a long-term source of return for the pension fund.

"Switzerland has high immigration, with around 80,000 people moving into the country every year. This influx creates a demand for houses and apartments, provided those homes are in the right location," he says. For this reason, the pension fund is likely to keep its 75% allocation to the residential market for the time being.

"As an investor, it's important to pick residential properties that are in the best locations. They must have good connections to infrastructure - being close to trains, bus routes, and so on," he says.