Liquidity key as appetites change
The trend amongst institutional investors worldwide is to increase their holdings in property, because of the stability of cash flows, low correlation with other asset classes and the fact that dividend yields are high in comparison to other investments (6% and above). This means that a large proportion of institutional investors are gradually raising the percentage of property in the portfolios to 10% or higher.
A big question is how to obtain exposure to the property sector. Should the investments be directed towards direct property, non-listed property vehicles or listed property companies/funds?
There is less appetite to invest in direct property than in the past. Many institutional investors have bad memories of owning buildings in remote cities or countries, which were hard to manage but fun to visit. The largest institutional investors are the exception. They still invest in direct property as they can achieve the scale of operations to make such investments worthwhile. They are concentrating their direct property investments in the domestic market.
This means that an increasing share of investment is going towards non-listed vehicles and listed property securities. Liquidity, corporate governance, cost structure and size are elements in which the listed property sector has a sound track record due to its longer history. The fact that countries like France, the UK, Finland and Italy are creating REIT structures only increases the appetite of investors further. The role of listed property securities in the investment portfolio of institutions is twofold. First, roughly 10% is being put into listed property securities for the longer term. Second, free cash from exiting a non-listed fund will be temporarily placed in the listed sector as well.
The non-listed sector has existed for only about five years in Europe but is growing quickly. Because of its short history, investor concerns like predefined exit scenarios, voting rights for participants and reasonable cost structures have to be tackled.
The listed sector is enjoying increasing interest from investors. This comes not just from institutional investors looking to increase their property holdings but also from equity fund managers looking for stability in investment portfolios and private investors looking for the same. Property stocks make up 6% of the MSCI Europe index, up from virtually zero some five years ago.
There are several ways to gain exposure to the listed sector.
q Internal management by investor. This is usually only done internally by the largest institutions as it is a specialised business requiring specific knowledge. Because the number of listed property companies on Europe’s stock exchanges has been declining through delistings, mergers and takeovers, an increasing number of investors has been outsourcing this task to specialist fund managers.
q Internal management: the new EPRA ETF. The European Public Real Estate Association (EPRA) is launching two exchange-traded funds – one on the Euro-zone containing 26 continental European property stocks and one on the UK, containing 33 UK property stocks. The ETFs will be managed by AXA and market makers will be Kempen & Co, GS, ML and MS. If these ETFs become a success, there will be an immediate positive effect on the liquidity of the underlying shares in Europe’s property companies.
q Outsourcing: The most important trend in the field of outsourcing is to choose a combination of actively and passively managed accounts for European property stocks. The major argument for investors to direct part of their assets towards passive management or index tracking is the relatively small European listed property sector of roughly 50 tradable stocks.
Thanks to the trends already mentioned, the liquidity of listed property securities is rising steadily. We expect this to continue. The trend could be reinforced as market players start using the the EPRA ETFs to hedge their exposure. This will produce additional liquidity in the underlying shares. There are already 26 European property stocks with a liquidity of more than e1m a day; the average liquidity of these shares has risen by 54% over the past three years (see table). Almost 50% of trading in the European listed property sector is done in block trades instead of through the stock exchange. The advantage of a block trade for both buyer and seller is that there is no impact on the share price. This implies that investors should use specialised brokers to execute their orders, because they run the risk of destroying their own prices when using non-specialists.
Max Berkelder is director of research at Kempen & Co in Amsterdam