Shayla Walmsley explores what the recent stock market sell-off means for listed real estate investors
If ever there were a time to regret switching to listed real estate, now is it - that is, unless you're taking advantage of plunging share prices to hoover-up bargains at the bottom of the market. Investors in listed property securities and real estate investment trusts (REITs) may be suffering equity volatility along with everything else on the stock market, but that doesn't mean they'll rethink, pull out and flee to non-listed property.
For one, they would have to believe it was an equity investment in the first place. Some investors, such as the NOK3.1trn (€393bn) Norway Pension Fund Global, do not necessarily view listed real estate as an equity investment at all. As it ploughs its efforts into reducing its European equity holdings, following a decision taken last summer to re-weight European equities to neutral, the Norwegian sovereign wealth fund has been building up significant shareholdings in UK property companies such as Land Securities and British Land.
Others, such as Dutch pension manager APG, which invests in the same UK property operating companies as the so-called oil fund (though, in both cases, slightly larger holdings), do not draw tactical distinctions between listed and unlisted.
"From the academic point of view, there's not much of a difference - both listed and unlisted will be driven by fundamentals in the end," says Steffen Sebastian, professor of real estate finance at the IREBS International Real Estate Business School. "But with listed, there is always the danger of reacting quickly and directly. There's a time lag before unlisted notices because the information isn't that quick. If you're looking for short-term results, it's better for unlisted at the moment. On the other hand, volatility can provide opportunities if you see them."
Second, a pension fund invested in property equities does so in the expectation that, in the long term, it will perform like real estate while, in the short term, it will behave more like equities - with equity volatility to go with the equity premium. In other words, volatility is part of the deal. Consequently, the short-term volatility isn't necessarily a major issue for pension funds, which in any case are more likely to use it tactically - for instance, to introduce liquidity.
"One thing is sure - we'll see lots of overreactions across the market," says Sebastian. "It starts with a correction, then there's an overreaction, then comes another correction of the overreaction. If I could distinguish a correction from an overreaction, I'd be a rich man."
Third, pension funds and insurers tend not to move that fast when it comes to assets. Dirk Brounen, professor of real estate economics at Tilburg University, points out that long-term investors are likely to hold on even to underperforming real estate equities. A study he led, published in IP Real Estate back in May, found that, while hedge funds were likely to react to short-term fluctuations, long-term investors such as insurance companies held tight.
Although he points out that the study observed the actions of investors, not their motives, it is reasonable to infer that "some investor types appear to be more loyal", even when returns become volatile. "I assume," he says, "that this also applies to the current market circumstances."
Why? Brounen believes the reason is that long-term investors are more likely to hold listed real estate to meet a portfolio mix requirement. So they're less likely to shift this when risks increase because many investors still consider listed property less risky than common stocks. "So, in short, yes, our results would apply today, but we can't give guarantees," he says.
There are reasons to allocate at least part of a real estate portfolio to listed investments - not that there's a consensus among institutional investors on it. "Half the investor universe thinks it's a good opportunity and a safe haven," Sebastian says. "The other half thinks it will be harmed by volatility."
One rationale, offered by EPRA spokesman Dominic Turnbull, is the mooted hedge against inflation - especially with the US committed to low interest rates until 2013.
Here's an even more compelling one: there aren't many alternatives. Global diversification with transparency - for example, via the requirement to disclose fair value - is pretty difficult to get hold of any other way. For small pension funds, listed offers relatively speedy exposure to global real estate. For larger ones, it introduces liquidity into an otherwise illiquid portfolio.
As Douglas Crawshaw, senior investment consultant at Towers Watson, points out: "You have to accept that you won't be able to get global diversification with [non-listed] funds - you have to go to REITs."