The fixed index-linked cashflows provided by social housing and infrastructure investments can be attractive to investors comfortable with long-term investing, finds Nina Röhrbein

Austerity measures can create the most unlikely investment opportunities for pension fund investors. Among those are investments in social housing or social infrastructure.
Social housing provides accommodation for low-income families, while social infrastructure includes a wide variety of assets such as nursing homes, medical practices, student accommodation and prisons.

In the UK, there is a critical shortage of social housing, with about 5m people, or 1.8m households, on waiting lists for accommodation.

“Government austerity measures have limited the finance available to the sector, while funding from the traditional lenders, the banks, has dried up,” says Phil Ellis, client portfolio director, real estate, at Aviva Investors. “This has created an opportunity for pension funds to step in and fill that gap.”

Secure, high-quality assets that meet their liabilities make social housing and infrastructure investments attractive to pension funds.

“Those investments tend to be long-dated, often with inflation-linked cashflows, and can generate 2-3% over index-linked Gilts net of fees, without taking much risk,” says David Bennett, managing director in the investment consulting team at UK consultancy Redington.

However, such investments do not fit into traditional asset classes and therefore require a change in attitude as to how pension funds think about their asset allocation. They have matching characteristics but with returns that are closer to those from equities. But unlike index-linked Gilts and swaps, social housing and infrastructure assets cannot be marked-to-market daily and therefore, although the cashflows from the assets should be a good match to the liabilities, their market value changes might not closely match the mark-to-market changes of the liabilities over short to medium-term horizons.

Only a small number of pension funds currently invest in these assets. “They have to understand the asset class and become comfortable with the idea that they can have a decent proportion of illiquid assets,” says Bennett. “Another challenge is finding an asset manager with such a fund.”

According to an EDHEC-Risk Institute paper entitled ‘Pension Fund Investment in Social Infrastructure’, no more than $10bn (€7.76bn) of equity capital was invested in social infrastructure between 1995 and 2010, mostly in the UK, out of a total of $100bn capital investment essentially financed with bank debt.

The Austrian Valida Pension has invested €20m in a social housing fund in 2012, which currently invests in nursing homes. It decided to invest in social housing for several reasons. “Social housing is a market with great potential for growth, and we expect a solid performance of 4-5% per year as well as low risk,” says Georg-Viktor Dax, board member at Valida Pension. “In addition, investments in the welfare of retirees is part of our sustainability strategy. The social housing project we invest in is not listed, meaning it is not influenced by business cycles but by long-term socio-economic trends. But it is an opportunity we grasped - social housing is not a mainstream investment.”

The main risk of social housing and infrastructure investments is their illiquidity, although the risk of loss from default is small. “Provided investors buy and hold the asset and it continues to deliver the expected cashflows, there are few risks,” says Bennett. “If something does go wrong, in most cases investors have some form of collateral or protection.”

However, excess demand and long waiting lists for social housing mean, some political interference in the sector cannot be excluded.

“But judging by the current political system, and despite various pressures, it is unlikely that any government would seriously damage the social housing model,” says Bennett.
There is a very small risk in relying on the housing provider, a registered social landlord (RSL), being a housing association or local authority, but Ellis believes these are well-managed and well-resourced in terms of their housing stock, and heavily regulated by the Homes and Communities Agency (HCA).

Aviva Investors, for example, only deals with the top 30 to 50 of the approximately 1,700 registered housing providers in the UK.

As most social housing investments are much more longer-term than mainstream real estate ones, typically with 45 to 50-year contracts, they are not subject to the ups and downs of the property rental market. “Instead, they are fixed index-linked cashflows. In other words, every year the rent payable will go up by the UK RPI or similar,” says Ellis. “The income stream is fully amortised with capital paid back and with the value going down to zero at the end of the term, the pension fund investor is not left with any residual risk.”

Aviva Investors’ preferred investment model is sale and leaseback on newly developed, high-quality stock. “The approach is the most attractive, as we can hand the freehold back at the end of the contract period,” says Ellis. “And we will only enter into an agreement to buy the finished product. The alternative is to buy existing stock meeting modern housing needs or to do a stock transfer.”

Social housing may also have potential to originate loans specifically designed to meet pension fund requirements. “It takes time for the social housing community to come around to the idea of engaging directly with pension fund investors and borrowing from them,” says Bennett. “However, there is evidence that this is starting to happen. In infrastructure, it is more about getting hold of secondary debt because a large proportion of it is sitting in banks. Banks do not want to sell these assets at a loss but there has been some movement on that front as well.”

“With social infrastructure investments like prisons, governments pay predictable revenues, possibly with an inflation link, which makes them a stable type of investment unless the government changes its mind about the benefits of private investment, which happens frequently in the infrastructure sector,” says Frédéric Blanc-Brude, research director at the EDHEC-Risk Institute and author of the social infrastructure paper.

Today, there are three routes to unlisted social infrastructure investment - infrastructure funds that tend to be structured like regular private equity funds, direct investments in projects and, in the near future, debt funds.

While Bennett also sees opportunities in various social infrastructure projects, in the UK, he believes, investors want to keep social housing funds relatively pure. “One or two funds have broader mandates, which would allow investors to get involved in a wider range of investments, although these do not fit into a narrowly defined social housing fund,” he says. “However, these could fit into long-dated lease or inflation opportunities funds, which provide long-dated inflation-linked cashflows and a relatively high level of security.”

Sweden’s third national buffer fund, AP3, has invested in a domestic social infrastructure portfolio through its property joint venture Hemsö Fastighets. The investment has attractive features such as long leases, low tenant risk, a strong market position and growth opportunities. It also has a different return pattern to that of AP3’s main asset classes, providing an important diversification effect. The portfolio includes schools, health centres and nursing homes in Sweden.

AP3 is invested in real estate equity only. Local regulation means that investments in debt would not be viewed as a real estate.

“We have undertaken investments in listed assets but we mainly look for pure-play opportunities that adhere to our regulation,” says Christina Kusoffsky Hillesöy, head of communications and sustainable investments.

Although social in name, environmental, social and governance (ESG) is often an afterthought with these types of investments. “Pension funds will put the investment case first, and if they find they gain an ESG benefit as well, it helps to strengthen their case,” says Bennett.

“Diversification and returns are more important to pension funds, although some public sector pension schemes might also be driven by an ESG perspective,” says Ellis. He adds that, so far, all of the pension funds that have invested or shown interest in social housing integrate ESG in their investments.

The biggest challenge for the sector is the limited number of projects and funds available. This means the range of investment opportunities in social housing is restricted. But Bennett believes that demand and supply will grow substantially.

“Demand for financing from the social housing sector will grow once this new funding model is established,” he says. “On the infrastructure side, the potential supply is enormous, the question is how to unlock it.”