Real estate continues to be attractive to multi-asset investors. Rachel Fixsen asks six institutional investors for their views of the asset class
As a relatively new pension scheme, the French pension fund for civil servants ERAFP is building up its exposure to property. “ERAFP is a recent scheme and regulation allows us to invest in real estate since December 2010,” explains Catherine Vialonga, CIO of the €14bn fund, which was created just a decade ago. “We are building our exposure and want to invest step by step,” she says.
The fund’s first aim is to have real estate exposure of 1.5% by the end of 2013. One mandate has already been awarded this year to AEW Europe to invest €310m in French properties over a three-year period.
“Another external investment manager is to be selected in the course of this year to buy properties in Europe,” Vialonga adds. This mandate will be for €350m of investment – and will also run for three years.
Real estate has several benefits within the overall portfolio, compared with the two most traditional asset classes, according to Vialonga. Seen against fixed income or bonds, property investment offers a premium that ensures acceptable absolute yields for the fund against the background of today’s historically low interest rates, she says. Compared with equities, real estate offers stable and regular cash flows – and with less volatility.
“Globally, real estate offers diversification from bonds and equities, enhanced returns thanks to the illiquidity premium and protection against inflationary pressures,” Vialonga says. “Real estate totally suits our investment profile, given our long-dated liabilities to be covered by the investment of strong net-positive cash flows for the next 20 years.”
Looking ahead, infrastructure could be another way for ERAFP to spread risk. The fund categorises infrastructure separately from real estate in its asset allocation, but, as yet, has no firm views on the asset class.
“We are just starting building ERAFP’s experience in real estate,” says Vialonga. “Infrastructure might be another kind of diversification for the regime – for us, the asset class is as attractive as real estate.”
PGGM is very clear about its reasons for investing in real estate, and sees no reason to deviate from its long-standing allocation level.
“PGGM has been a successful real estate investor for decades, and the allocation has always varied between 10% and 15% of the total portfolio,” says Eloy Lindeijer, CIO at PGGM, which manages around €140bn for five Dutch pension funds.
The pensions administrator has 12% of total assets under management in real estate, which equates to around €16bn.
The exposure is on target, Lindeijer says. “PGGM strongly believes in diversification and we feel comfortable a 12% real estate allocation.”
He points out that PGGM’s real estate and infrastructure investments are mainly a result of their largest client PFZW’s allocation in the portfolio.
“The total real estate portfolio has a 50/50 split between public and private real estate and is currently in line with the allocation mix,” Lindeijer says.
He says there are three main reasons for investing in property, none of which he expects to change soon. Real estate – and private real estate in particular – gives diversification, it provides relatively high direct income, mostly based on rental income, and the asset class also has some link with inflation, he says.
Around 10% of PGGM’s property portfolio is invested in the domestic market, which Lindeijer describes as a rather limited level.
“The investments we have in the Netherlands can be qualified as core – best locations, well leased and low leverage,” he says.
“Of course, there are challenges in the Dutch real estate market, but with PGGM’s investment focus on income generating assets – offices, parking garages and retail – and the majority of the Dutch portfolio invested in the residential market we will be able to make it into the next more positive cycle,” he says.
Danish pension fund Industriens Pension is making a significant change to its real estate allocation over the coming year by putting substantial amounts of money into the domestic market for the first time.
“We’re doing this for two reasons,” says Jan Østergaard, CIO of the fund. “Danish properties are not as expensive as they used to be, and the returns on other investments are quite low at the moment.”
The pension fund has said it will put DKK5bn (€671m) into Danish real estate over the next few years, and Østergaard says the fund will also boost its overall allocation to real estate more generally.
Right now, just over 2% of the pension fund’s DKK100bn in assets are held in property, primarily outside Denmark.
“We will put in at least DKK1bn yearly, and probably more,” says Østergaard. “Quite soon, I would guess our allocation to real estate will reach 5% of total assets and will grow from there.”
At the moment, most of Industriens Pension’s real estate exposure is achieved via real estate funds and it intends to continue investing that way outside Denmark. “We’ll have two investment tracks: direct investments in Denmark and we’ll continue investing in funds – targeting the more opportunistic, value-added ones – and we expect to make co-investments as well,” he says.
Opportunities arise from managers running funds in which Industriens Pension is already invested. A property that is too big for a fund may be offered to a number of the fund’s investors on a co-investment basis. “The advantage is you don’t need the same amount of due diligence because you can rely on the fund´s due diligence,” he says.
Last year, Industriens Pension transformed the entire scheme to one based on unit-link investments, moving away from traditional with-profits pensions with yield guarantees.
“It means we only have a very small amount of liabilities. That being said, we can’t just deliver a long-term return of 2-3%, so we have to find some ways of increasing that,” Østergaard says.
European pension funds have kept their allocations to real estate at broadly the same level recently, although some have made geographical changes within portfolios, according to Douglas Crawshaw, senior investment consultant at Towers Watson.
“There is an increasing focus on global diversification, and this may mean reallocating existing capital or using new capital as it comes into the scheme,” says Crawshaw, who is head of UK and European real estate for the consultancy.
While pension funds can get immediate exposure to global property via listed investment vehicles, they are typically increasing geographical diversification step-by-step for unlisted real estate, he says.
A UK pension fund, for example, holding unlisted or direct real estate in the UK would be likely to add to its core exposure by investing in northern Europe before moving on to markets further afield, he says.
“Reasons for moving away from the home market are political and economic, and I would also argue geological,” he says. After all, different parts of the world are subject to different physical risks, such as earthquakes.
Allocations to property may be relatively stable for now, but Crawshaw certainly sees factors at work in the pensions sector that could lead to higher overall allocations in the future.
Property is becoming more attractive to schemes as their need for long-term, secure income intensifies, he says.
“As defined benefit schemes start to de-risk and mature, real estate can stand in as a better yielding proxy for the assets they would naturally buy, such as gilts,” Crawshaw says.
“Even for the less mature schemes that may have a deficit, if they can bear the illiquidity, they can move to property and benefit from the added value.”
The shift towards defined contribution (DC) means pension schemes have to find the right kind of real estate products if they want invest in the asset class. “The big issue for DC in the UK is that it requires daily liquidity, and that is something the provider has to overcome when investing in property,” says Crawshaw.
Standard Life Investments
Standard Life’s asset allocation to real estate is based on a three-year horizon, and has been broadly unchanged for the last 12 months.
“We believe that income rather than capital appreciation will remain the key driver of real estate returns and our portfolios are positioned accordingly,” says Anne Breen, head of real estate strategy and research at the institution.
“Our house-view allocation to real estate is heavy in North America and the UK, and neutral in continental Europe and Asia Pacific,” she says. “At a more granular level we favour core prime locations, better quality assets and turnaround opportunities.”
Global real estate investment offers a large income premium over government bonds and cash in many markets – after taking fees into account – and appeals to those looking for sources of sustainable yield, Breen says.
“The gap between the yield on real estate and the yield on a proxy for the risk-free rate – government bond yields – remains close to record levels. Another potential advantage from real estate investment is inflation protection.”
Breen adds that a large proportion of rents in the UK, US and much of Europe are fully or
partly indexed to inflation.
For long-term investors, property is still a relatively attractive asset compared to other asset classes, she argues. “In broad terms, it is a long-duration asset with a reasonable income after expenses. As asset-liability management techniques become more sophisticated, funds are moving away from the traditional bond and equity split.”
That said, pension schemes are well aware of the business-cycle risk attached to property, and there are risks in the global recovery, she says.
Some are concerned about the overhang of loans and property still held by commercial banks from the 2008 crisis. “However, a lot of these assets are poor quality, non-investment grade stock,” she says. “As in the 1990s, banks are expected to take a measured approach to working through these non-core assets.”
Tesco Pension Investment
The £6bn (€6.98bn) pension fund of UK supermarket chain Tesco still has a tenth of its assets in property, unchanged since the fund established in-house investment team Tesco Pension Investment (TPI).
“When TPI was set up in 2012, we inherited a range of investments from the teams who’d managed the fund before,” says Steven Daniels, CIO of the company.
Since then, the team has continued with the 10% allocation to real estate, but has fine-tuned the strategy. “We are focused more on the UK as that is the market we know and understand best, and it’s certainly big enough to offer a range of opportunities for a fund of our size,” Daniels says.
There are numerous opportunities in the UK market, he says, but unlike previous cycles, TPI does not believe this one is about getting sector allocations between retail and offices correct. “Instead we are focused on property fundamentals particularly in supply-constrained markets,” he explains. “In common with most investors we see merits in London and the south east but we also see opportunities in the regions.”
The trustees of the Tesco pension fund have told TPI to look for growth opportunities in the medium to long term, and as an asset class Daniels says real estate fits those priorities well.
“But, like all asset classes it’s difficult to look at real estate homogeneously,” he says. “We do see lots of opportunities given the relatively high-income return from real estate. However, there are some parts of the market, like central London, where we see potential but which we regard as relatively expensive because high demand has reduced the yields.”
TPI tends to consider real estate and infrastructure together, he says, remarking that the lines between the two asset classes are blurring. “Infrastructure investments can sometimes look like real estate or equity or bonds, depending on the specifics of each investment opportunity,” he says.
“We have deliberately built a team with a range of expertise in all these areas, so we can assess each opportunity on its merits and invest accordingly.”