German insurance companies and pension funds plan further expansion of their real estate portfolios, says Alexander Kähler
A survey conducted by Ernst & Young Real Estate GmbH has revealed that German insurance companies and pension funds intend to raise their indirect real estate investments by 25% (compared with the same period last year) by the end of 2008. The idea is to reduce the relative share of direct investments.
This would cause the indirect investments of insurance companies and pension funds to exceed the direct holdings, on average, for the first time ever. As recently as the beginning of the year, the ratio still stood at 45-55%. As the survey shows, this development represents more than just a shift in real estate investments for insurance companies and pension funds.
More than two-thirds of the polled companies mentioned plans to raise their real estate quotas by the end of 2008. On average, companies seek to increase their real estate portfolios by 10%, which would bring the real estate share of their capital investments up to 7.35%.
While insurance companies and pension funds deem returns of 4.9% acceptable for direct investments, they expect substantially higher earnings from indirect real estate investments; the benchmark is an average of 6.1%. The companies believe that open-ended institutional property funds are more qualified than others to meet these yield expectations; seven out of 10 respondents stated they intend to invest in such vehicles. Equally popular are closed-end property funds and private equity companies.
By contrast, just 10% of all insurance companies and pension funds consider mutual open-ended property funds an option for capital investments. Something of a surprise are the findings in regard to preferred types of usage. In reply to what kind of real estate they intended to buy, respondent companies most frequently identified retail, followed by office and logistics properties.
European countries count among the most popular acquisition targets of insurance companies and pension funds. Then again, many wish to exploit the Asia trend: a steep rise in population, increasing urbanisation, and substantial growth of the gross domestic product in many regions promise high returns.
Companies have long ceased to limit their investments - most of which are transacted through special funds under Luxembourg law - to established markets such as South Korea, Japan, and the city states of Hong Kong and Singapore, going on to include emerging markets such as China and India.
Investments in Asia require much more effort than commitments in Europe and North America, not least because of cultural differences and a sometimes low level of market transparency. Hence, investing in funds that target Asia is not a paying proposition for every insurance company or pension fund.
Moreover, many of the offered funds were launched only recently and therefore lack a demonstrable track record. Rating the quality of asset managers there is even harder for insurance companies and pension funds than it is with investments in Europe and North America. For small and medium-sized insurance companies and pension funds in particular, funds of funds represent the optimal alternative, not least for reasons of diversification.
Even if some insurance companies and pension funds aim for investments on emerging Asian markets, the overwhelming majority of the companies focus on the investment segments core, core plus, and value add. Around 20% are planning to engage in opportunistic real estate investments this year.
Insurance companies and pension funds have traditionally favoured stable commitments when it comes to real estate investments. One reason why high-risk real estate investment products are shunned is that they can rarely be allocated to the real estate quota. Yet for many insurance companies and pension funds it is of significant importance whether investments can be added to the real estate quota or not.
More than half of all insurance companies and pension funds are planning to invest in residential real estate in the coming year. In Germany more than elsewhere, such investments are attractive now that many international investors have retreated. The fact that residential real estate tends to generate stable cash flows complements insurance companies' and pension funds' need for security.
Whenever the properties are located in regions where the number of households is growing, the vacancy risk is also much lower than for office and retail. Accordingly, 55% of all insurance companies and pension funds intend to reduce their office inventories before the end of the year, whereas just 15% plan to sell their apartments.
The main finding of the Ernst & Young Real Estate survey is that the real estate investment activities of insurance companies and pension funds are subject to a structural change. Today, most insurance companies and pension funds have woken to the fact that the in-house management of real estate is costly and not part of their core competence.
Increasingly, this realisation is causing companies to outsource these areas, either handing over their real estate management to external providers or disposing of their direct holdings altogether. For many insurance companies and pension funds whose real estate expertise is limited to Germany and perhaps the neighbouring countries, indirect investments present a first-ever opportunity to commit themselves abroad.
Having initially limited their investment horizon to European countries outside Germany, they have since targeted North America and Asia. Whether the future will bring a further shift of focus on new regions for the insurance companies and pension funds remains to be seen. For now, the novel forms of investment chosen will have to prove their merits by yielding returns well worth the risk.
Alexander Kähler is head of real estate insurance and pension solutions and partner of Ernst & Young Real Estate GmbH in Munich