A beneficial part of the blend
The size of the global institutional real estate market for the major markets highlighted in table 1, shows the total size of the underlying global market is just under $6trn (e5trn). North America, the largest market (42% of the total), has assets in the region of $2.5trn, with 12%, or just under $303bn, in securitised form. Continental Europe is the second largest market, holding 25% of total global assets, although - amazingly - only 4% is listed. In terms of listed product, Australia is head and shoulders in front. Approximately 52% of the Australian property market is securitised, highlighting the success of the listed property trust (LPT) structure. The UK has the second highest level of securitisation, with 17% of its $490bn property market listed. On average 11% of global real estate is listed, comprising 2% of global stock markets.
The Pension Real Estate Association (PREA), in its 2004 survey, based on a $1.7trn universe of pension plans, endowments, foundations and other funds, found that investment in real estate equity (both listed and unlisted) was approximately 5.2% of total assets for those that actually had a real estate allocation.1 Real estate investment trusts (REITs) represented 15% of the total ‘real estate’ allocations for the survey, demonstrating the willingness of pensions funds to hold listed real estate as part of their overall real estate allocation. The survey’s respondents stated listed real estate enhanced diversification and liquidity benefits of real estate allocations, particularly for smaller funds. The survey indicated that 85% were below their target allocation, implying more real estate investment in the future.
Market research predicts average property allocations worldwide will increase over the medium term to 10% of investor portfolios, from less than 5% now.2 This is being driven by many factors: moderating medium-term equity return expectations, a reduction in government bond issuance and, in particular, an increased demand for annuity-style returns from an ageing population.
A report by AMP Henderson Global Investors stated: “As baby boomers move from an accumulation phase to spending over the next two decades, we expect a shift in investment demand will occur from capital growth/low-income assets to higher income/ capital preservation-style assets. Property investment is able to meet this requirement, with an annuity style income.”3
In smaller, more sophisticated markets, listed real estate represents a heavy weight in property allocations. For example, listed real estate represents 70% of Australian real estate allocations and 50% of allocations in the Netherlands.4 In both cases, high levels of institutional ownership are related to high levels of securitisation. Australia and the Netherlands have had established REIT structures for more than 30 years.
Where do listed real estate stocks fit into a broader real estate investment strategy? Kempen & Co identified three mains areas of real estate investment in its European Property Sector – Compass publication. The three areas examined are: direct property, unlisted property vehicles and listed property. The firm estimates that a property investment portfolio of institutional investors will comprise 20% listed property, 50% non-listed property and 30% direct property in the future (see page 31).
In listed terms the European market is the smallest of the three regions covered by the EPRA/NAREIT Global Real Estate Index. Roughly the split between the regions is North America 50%, Asia/Pacific 30% and Europe 20%. Considering that the total real estate assets in Europe approach the $2trn mark, the listed portion is only $143bn, or 7% of the total market. The UK comprises over half of the market capitalisation in Europe. This would indicate the potential under the right conditions and the European market has some way to grow, certainly in continental Europe. Germany is the largest country in Europe in GDP terms but only has three listed companies of the size and liquidity required for the EPRA/NAREIT index. On the other hand, the German open-ended funds market is huge.
A passive investment strategy in the EPRA Europe Index would provide the investor with a broad and diversified portfolio represented by 12 European countries and five sectors. At a country level, the top five countries comprise approximately 83% of the European portfolio. The UK is heavily weighted, as you would imagine based on the information in table 1, at over 50%. The Netherlands weights around 15%, with France just over 12%. The sector breakdown offers investors 41% in diversified real estate companies, 25% focused on the retail sector, and 20% in offices. Industrial and residential are both around the 7% mark.
In an EPRA-commissioned report5, European property stocks have been shown to add value to a European investment portfolio over the past 10 years. The research report, conducted by Professor Graeme Newell of the University of Western Sydney (Australia), found that European property stocks delivered superior risk-adjusted performance over 1993–2002. Superior risk-adjusted performance was also evident for six of the 12 specific European countries examined, including UK and France.
This issue has been assessed for US REITs (NAREIT, 2001) and for Australian LPTs (Newell and Tan, 2003). In both the US and Australian scenarios, REITs and LPTs were found to provide significant portfolio diversification benefits, with increased levels of REITs and LPTs in the portfolio resulting in improved risk-adjusted portfolio performance and increased portfolio terminal wealth. Both features reinforced the ‘value-added’ investment performance of REITs and LPTs in these portfolios.
Other key features in this EPRA report were:
q superior average annual returns for European property stocks compared to European shares, but at a lower level of risk;
q superior risk-adjusted returns for European property stocks compared to European shares;
q high correlation between European property stocks and European shares performance, with this correlation reducing in recent years, reflecting improved portfolio diversification benefits.
The significant role of European property stocks in a mixed-asset portfolio of European shares, bonds and cash was clearly evidenced as the level of European property stocks in the portfolio increased from 0% to 20%. As shown in table 2, risk-adjusted portfolio returns steadily improved, with the portfolio terminal wealth increasing by 4.1%. By including property stocks in the portfolio, major increases in portfolio terminal wealth were also seen for UK (3.1%) and France (9.6%).
With six key investment performance criteria considered in this report, table 3 presents the performance checklist for each country or region against these six key criteria.
Historically, real estate has provided investors with excellent risk-adjusted returns. In addition, high-income levels, relative capital stability and low correlations with stocks and bonds make a simple but effective investment argument. The results of the EPRA diversification report clearly reinforce the strong value-added and risk-reduction benefits of European property stocks in a European mixed-asset portfolio. There has been, and will continue to be, a structural shift towards the asset class.
OECD forecasts predict that the proportion of the population in retirement will increase by more than a third to 21% over the next 15 years. In investment terms, this is driving people towards more capital stability with an income focus. Given the fact that people may need to live off investments, liquidity is also important, which of course favours listed real estate. Listed real estate markets are approximately 3% of global stock markets. If securitisation continues to expand under the current REIT trend, then real estate will become a much more significant part of broader equity benchmarks in the future, thereby increasing demand.
Fraser Hughes is research director of EPRA
1 For the entire universe the allocation was 3.4%, hence many plans have little or no position in real estate, PREA 2004 Survey.
2 AMP Henderson Global Property Securities: Investment Case for Australian Investors.
3 AMP Henderson Global Property Securities: Investment Case for Australian Investors.
4 UBS Warburg Global Analyzer, June 2004.
5 Full copies of this research report on The Diversification Benefits of Global and European Property Stocks, EPRA Academic Guide Publication. Available at www.epra.com or upon request at firstname.lastname@example.org