Disappointment over the new G-REIT has shifted the attention of German pension funds farther afield. Diversification is the clear driver, as Richard Lowe reports
There was a sense of optimism at the start of 2007 surrounding the imminent arrival of Germany's REIT regime. Last year's Regional Investor focus on Germany revealed that many pension fund managers were potentially open - albeit with a healthy level of caution - to the vehicles, while commentators forecast G-REITs to have a capitalisation of at least €50bn by 2010, a quarter of which would be derived from pension fund investors.
However, 12 months later the majority of German funds are far more concerned with gaining exposure to Asian real estate than looking to benefit from a new domestic REIT market.
The main drivers of this indifference are twofold: the heightened volatility of the world's property stock markets and the exclusion of residential properties built before 2007 from the new G-REIT.
"Because of the volatility of the markets, [pension funds] have seen that REITs and property equities have had a very bumpy road, and are rethinking whether they are able and willing to invest in REITs all around the world," says Juergen Olbermann, managing director at FERI Institutional Advisers.
"The main reason is volatility," confirms Hans-Wilhelm Korfmacher, managing director of WPV, a €1bn pension fund for chartered accountants. And Herman Aukamp, director of real estate at €8bn doctors' fund NAEV, admits that German REITs have "come at a very bad time in the property cycle" and their success "depends on the overall situation on the property stock market".
But Aukamp reveals that NAEV would have seriously considered the possibility of transferring some of its direct holdings into a REIT, had it not been for
a law forbidding the inclusion of residential real estate. Instead, the fund is "looking for a new vehicle" to dispense with a series of residential properties. Fortunately, it is widely expected that this rule will be overturned eventually, once enough pressure from the real estate industry is brought to bear on the government to adopt international guidelines and legislation.
"It will come out of the property investment industry - they should exert some pressure on it," Olbermann says.
In the meantime, pension funds continue to offload German buildings as they seek to move out of direct investments comprehensively. NAEV sold some residential properties in December and Aukamp says he was "amazed about the prices" received for these.
He adds: "This wasn't affected by the credit crisis at all, so we got very good biddings, very good prices."
BVV, a €19bn pension fund for the financial industry, benefited similarly when it sold some direct holdings in 2007 as part of its plan initiated in 2002 to eventually remove all direct investments.
"There are some interesting opportunities on the seller's side, so we sold a number of buildings and we had very good returns," says Rainer Jakubowski, board member and chief finance officer at BVV.
"That was because of the overall market situation - because of the yield compression."
Indeed, the outlook for the German real estate market is positive, especially when compared with some of its European neighbours. It is not surprising, therefore, that, despite transferring direct investments, pension funds are by no means abandoning their domestic market.
"It does not mean we are not investing in Germany. The opposite is the case," says Jakubowski, who explains that BVV is currently in the process of identifying German assets for its immobilien-spezialfonds (ISF).
ISFs are property funds created for pension schemes, insurers and other institutional investors. In exchange for investing at least €25m, an ISF affords them considerable transparency, lower fees and good deal of control over the investment process. To set up an ISF, the institutional investor can either work with external managers or pool money with others to acquire properties internationally.
Jakubowski is relatively positive for the German real estate market in 2008, but is understandably less confident to make any forecasts beyond this period.
"I am always careful with a prognosis for a long period of time," he says. "It is not our job to foresee the future. We have to be prepared for several different situations." The threat of a US recession is inevitably going to dampen market optimism anywhere in Europe. Aukamp is very sceptical of the decoupling argument and believes that no country, not least Germany, will be immune to developments in the US economy.
That said, Aukamp believes the tendency of the German real estate market to lag behind others may have the positive effect of making any correction less harsh or sudden than that experienced elsewhere. We always said we wanted to stay in the German market," Aukamp adds. "Especially at a time when the German market - when compared with other European markets - is in a stable condition."
Despite the recent troubles in the world's real estate markets, there is often talk of a significant wall of capital still seeking to invest in the asset class. German pension funds certainly lend evidence to the notion.
Over the last 10 years, pension funds have increased their allocations to real estate from the region of 3-5% to around 10-15%, with the largest increments taking place in the last five years. Most funds have yet to reach their desired quota, mostly because of commitments made in recent years to ISFs and other vehicles that are still in the investment phase.
"They have a lot of commitments that are not invested yet," says Olbermann. "They are two-thirds of the way."
WPV's asset-liability study in 2007 saw its real estate allocation rise from 12% to 15%, primarily driven by concerns about equity market volatility and the conclusion that "risks in many other asset classes" were "not paid in the right way".
Korfmacher adds: "Therefore, WPV reduced its exposure to higher-risk asset classes with high volatility and increased its exposure in real estate during the last year."
But where is this growth in capital heading? A significant part of it is undoubtedly heading out of Germany and Europe and into Asia.
Olbermann notes that some of the larger pension funds have started to invest in the region. For example, BVV invested in Asia for the first time in 2007 and plans to increase its exposure in the future. And the €5.6bn pension fund of energy company E.ON is already invested in 13 pan-Asia funds - a mixture of core and value-added sector funds - and intends to invest in some country-specific funds.
"Asia is a very important market," says Alexandra Trost, portfolio manager at the fund. "We started with Singapore and Shanghai core markets, so the risk was very low but you could receive high returns. Now we are also invested in India and more in China. At the moment we are watching the Korean market."
Even the relatively small WPV has sought exposure to Asia. The pension fund is young by German standards, having been established in 1993, and unlike older funds has never held any direct investments. Instead WPV has built a diversified indirect real estate portfolio across Europe, which it identifies as its "domestic market" rather than Germany specifically.
For its first foray outside Europe, WPV has invested in a fund of funds that invests in Asian bricks and mortar to immediately gain a level of diversification throughout the region.
"We will go to Asia in the same way we started our investments in Europe," Korfmacher explains. "Diversification is the key to investments in all markets.
"We did invest in a great number of different vehicles in Europe but now we are experienced investors and so can reduce the number of investment vehicles while still having broad diversification. In Asia we will do the same: investments in different vehicles and then we will gain more experience in identifying which vehicles to invest in."
Meanwhile, Asian investments make up 18% of NAEV's total real estate portfolio. It is envisaged that this could gradually rise to 30% in the long term. Aukamp explains that the pension fund has identified "development opportunities" in certain Asian markets. This outlook is tempered with anticipation for "some weaker development activities" and Aukamp says the fund is cautious in all its real estate investments.
"We have seen good results. It will probably be much more difficult to get good results now," he admits. In fact, as previously noted, Aukamp does not believe that Asia will be able to remain immune from the global ramifications of a US economic recession.
"Asia will not decouple 100%," he says. "Maybe it is able to do better and we believe it will do better at this moment, but if there is a recession in the US, obviously it will affect the markets in Japan and finally the whole of Asia.
"It is all up to managers now in these circumstances, especially in Asia. You should know who is on the ground now for your investments, who are the managers, and are you ready for markets that are not on the sunny side."
Aukamp says this applies to all markets in the current environment. "In the changing environment it is all about the quality of your managers now," he continues. "Have you got the managers who can cope with today's markets? You need decent asset managers and you need decent property managers now in these markets. This is my main concern. Are my managers able to cope with these markets?"
That German pension funds have been moving en masse to Asia can be explained as a natural step towards full global diversification, but how much of it is actually a case of institutional investors chasing returns?
Korfmacher emphasises that the need to diversify is the principal driver. "The main reason for investments in Asia and in other countries out of Europe is diversification," he says. "Diversification is the key to investment success."
According to Korfmacher, the decision to invest in Asia was not made according to market developments in the last 12 months or so. After Asia, the US market is in line to feature on the agenda. But here, Korfmacher admits, he is a "little bit cautious".
Certainly, Asia seems to be ahead of the US as the diversifier of choice. Olbermann explains that most pension funds are investing in Asia but not the US because of the weakness of the US dollar in recent years.
"The big wave to start investment in America has not happened," he says. "The big insurance companies have invested some money in US property, but I didn't see a major investment from the pension funds." Having said that, E.ON is already invested in 11 US funds, although the pension fund is not seeking any more exposure here - instead it is looking at new investments in South America (it already invests in two Brazil funds), such as in Mexico, and also Canada. Yet, the fund is evidently at the leading edge of the global diversification endeavour, having also invested in Russia and markets in central and eastern Europe.
The global spread of E.ON's portfolio is certainly what smaller pension funds will be hoping to emulate further down the line. But Olbermann believes that achieving this level of international diversification may start to become more easily and quickly accessible now that the potential of global funds of funds is being assessed.
"Fund of funds vehicles are coming up now and there are some very interesting structures if you want to invest globally, using specialised managers in each area," he says. "It is just in discussion at the moment, but a few are thinking about it. We think it is a very attractive way of getting a really diversified global portfolio."
Olbermann expects pension funds to invest in the vehicles initially in addition to their standard funds, "to test how it works". He says: "And if they get the asset allocation and regional allocation very well, they could increase the allocation of the funds of funds. And in the next few years we will see a strong growth and trend of pension funds thinking about investing in funds of funds."