IPE Real Estate spoke to five major European real estate investors about their views on asset allocation in real estate portfolios

The questions we asked
n What is your current allocation to real estate within your overall portfolio? Have you reached your strategic asset allocation levels?
n What is your short-term (next year) and longer-term (three to five years) strategy for real estate, in the context of your overall portfolio? Are you increasing, decreasing or holding the level of real estate investment and why?
n If the allocation is changing, how will these changes be made and over what timescale? How will you go about this and what type of investments will be made/sold?
n Looking at the real estate portfolio, how is it split between direct/indirect, home/international, and between sectors (retail, office, residential, industrial, etc)?
n Why has the portfolio developed in this way? What changes are likely to occur in the future to the make-up of the portfolio? Are there any ‘alternative’ real estate-related products (ie CMBS, derivatives, equities) which form part of the portfolio or might do in the future?
n How difficult have you found it to buy real estate assets, directly or indirectly in the current market? What means are you looking at to deal with this problem? Could a lack of suitable stock lead to less investment in real estate?
n What are the main downside risks for an investor in real estate in the current market?

Aqil Khan
Adimmo AG

Adimmo AG is sole manager of the Basellandschaftliche Pensionskasse (BLPK) real estate portfolio and is majority owned by the pension fund (with the rest owned by Adimmo’s management). Aqil Khan, head of indirect investments is going to be busy over the next few years, as BLPK increases the proportion of indirect and overseas investment in real estate.
“The current allocation of BLPK’s portfolio to real estate is 20%,
slightly higher than the average
allocation of Swiss pension funds, which is about 15%,” says Khan. “The current allocation to real estate is almost in line with the mid- to
long-term strategic asset allocation. The distinctive weighting of the real estate allocation is based on the
positive risk-return profile of
long-term real estate investments and the good compatibility of real estate to other asset classes regarding
BLPK is about to embark on a new four-year strategy which will involve a reduction in the residential segment of the portfolio and to increase the proportion of indirect investments. Currently about 12% of the real estate investments are held through indirect vehicles in Switzerland and the rest of Europe. This portion will be increased to 40%. Khan says the increase will be achieved through additional international investments and local asset swaps.
“Most Swiss pension funds are historically overweight in domestic residential. BLPK will substitute parts of the residential investments through more diversified investments. However, due to regulatory restrictions the international real estate investments of Swiss pension companies are limited to a maximum of 5% of the overall asset. Therefore, we will not be able to invest more then about €130m outside Switzerland.”
Khan says the BLPK is not currently planning on major new direct investments within Switzerland. The pension fund will also not be making direct investments in overseas real estate. “On an international level we see a major risk for investors making direct international investments. Strong expertise and market knowledge are essential,” he says. “You need to have the people on the ground. Also, you must have a strong and persistent network in at least the major countries or certain regions. In order to achieve solid diversification we believe that you need to invest at least €500m.”
Khan argues that to invest directly into international real estate an investor needs to have a significant organisation as well as significant investment volume. “We think, if an investor does not meet at least these criteria he is taking additional risk without an adequate (if at all any) risk premium.”
BLPK is taking a cautious approach to its overseas investment, says Khan. “Currently we are making careful steps regarding local and international indirect investments. There are various investment possibilities and products on the market. But in order to make solid and healthy investments you have to act very carefully on the current market. Even though we are planning to invest a certain amount of money within the next four years we will not make the respective investment at any cost.”
BLPK is a long-term investor in real estate and has a sound understanding of the market, but Khan worries that this does not apply to all new entrants. “There is a lot of new money coming into the market and price movements are bringing down the risk premium for real estate. More money will compete for the same products at the same time. Therefore, we are seeing a pricing and timing issue.”

Ton Zimmerman

The Nedlloyd corporate pension fund in the Netherlands is in the process of increasing its allocation to real estate. Last Autumn the group had 15.6% of its assets in real estate and at present the allocation is 16.1%. Nedlloyd has a strategic allocation of 20%.
Managing director Ton Zimmerman says: “We haven't reached our strategic allocation of 20% real estate yet. It is our objective to reach that by the end of 2006.” It has been a slow process, increasing the allocation in a competitive buying market. Nedlloyd had originally intended to reach its 20% allocation by the end of this year, but has had to push this date back.
While the fund is keen to reach that strategic allocation new pensions policy in the Netherlands could affect overall asset allocation.
“Most probably we will increase the actual allocation to real estate to the strategic level of 20%,” says Zimmerman “However due to the fact that starting 1-1-2006 a new financial assessment framework will be in force, which will make us value our pension obligations at a market interest rate instead of the fixed 4%, and due to changes in the fiscal policy the pension scheme – the abolishment of the ax facility on early retirement pensions - we will have to change.
“We are considering conducting an asset/liability study next year which might have an impact on the future strategic asset allocation. If changes do occur from the ALM study we will try to implement those as soon as possible.”
Furthermore, says Zimmerman, Nedlloyd will go along the lines of the strategic asset allocation, but (when looking at allocations to different sectors) will take into consideration the economic environment. For example the policy might be to underweight offices due to expectations of a sluggish economy or, based on improved economic assumptions, lift the underweight position of offices.
As at the end of May, the Nedlloyd Pension Fund has an actual allocation of 20.1% of the portfolio in residential properties, almost half of which is held indirectly. The fund plans to reduce the residential allocation to 17.5%. It is also slightly overweight in retail, where a current allocation of 38% is set to be reduced to 37.5%.
Zimmerman says Nedlloyd is keen to increase the weighting of offices in the portfolio, up from a present weighting of 28.9% to 35%. The ‘other assets’ weighting is 12.9%, which is set to be reduced to 10%.
Most of the portfolio, in line with Nedlloyd’s general policy, is held in the Netherlands, but through investments in unlisted funds, it now has 2.7% of its portfolio in international real estate. Most of the portfolio is held directly, but 15.6% is in unlisted funds.
“Our strategy is based on getting the real estate characteristics into the asset allocation of the fund and not mix that with the equity characteristics, so our preference is direct real estate or indirect non quoted participations,” says Zimmerman. “When there is no suitable real estate or participations available this might lead to either higher prices or less investment.”
He says Nedlloyd believes the main downside risks are lower economic growth, which might lead to less investments and less demand for office space. As far as the consumer is concerned, inflation might lead to higher interest rates which would be bad for the residential sector.

Robert-Jan Tel

TKP is the pensions administrator for two of the Netherlands’ largest pension funds, TPG and KPN, which pool the majority of their real estate assets in what is effectively a fund of funds structure, says TKP head of real estate investments Robert-Jan Tel.
The group has €7.5bn invested overall, of which just under 10% is in real estate. Approximately 30% of the total is invested in offices, 17% in retail, 17% in residential, 18% in industrial and logistics and 18% in parking. Most of the portfolio (52%) is in the Netherlands, with 12% in France, 12% in Spain and Portugal, 10% in Germany, 8% in the UK, 4% in Italy and with small amounts in central and Eastern Europe, Scandinavia and Belgium.
In order to gain access to specialist management and to reduce costs, all the investments are in indirect funds and have been built up since 1998. A large part of the holdings in the Netherlands are residential, says Tel. “These form a sold, low-risk part of the portfolio.”
Most new money will be allocated outside the Netherlands, so the proportion of domestic real estate will fall, says Tel. However, the domestic exposure will not be sold down. There are no plans to invest outside Europe at the moment.
“We believe in more active strategies, in value-added and growth funds, but the problem is that your money is often not invested all at once and is also realised over a number of years,” says Tel. “Doing indirect investments means its more of a challenge to manage your cash position well and balance outflows from capital calls with inflows from earlier funds. We have to look further ahead and manage our cash position 3-4 years ahead. The advantage with having a portfolio of our size is that it helps you to manage the cash position.”
TKP has cash unspent for 2005 and Tel says it is harder to get money in to some markets because of the weight of money from investors. As funds are not remaining open as long as in previous years, investors have to be more proactive in finding funds and managers.
However, he believes that the influx of new investors means the supply of new funds has increased and there are more and better managers. “The market as a whole is professionalising as well. Funds have become more investor-friendly and more investors are getting involved with issues like corporate governance and fees,” he says. “There have been some improvements in the sector as a whole, such as reporting and valuations, which make the market more accessible for pension fund investors.“
Looking ahead, Tel says it’s hard to predict but he believes the allocation to real estate will be stable or growing. “In general, pension funds in the Netherlands are investing more to alternatives and real estate is a favourite.”
At present the funds invest only in indirect funds and this is unlikely to change. “We don’t invest in real estate equities. The decision was made in 1998 to invest in unlisted real estate because it correlates more with the direct market and less with the equity market than real estate equities. In the future we could do some listed property in order to find liquidity, for example, but there are no plans right now.”
Tel argues that the main risk to the European real estate markets comes from the disconnect between the occupier and investment markets. In several countries the economy is a little bit sluggish and the occupier markets are week. But there is so much pressure of money that record prices are being paid for the best property. “So there is a price risk and not much upside in these sectors at the moment,” he says.

Mike McCook
CalPERS is the largest pension fund in the world, holding $180bn (e151bn)of assets for the benefit of 1.4m members, employees or retirees from the state of California. It has been investing in real estate since the 1980s, entirely domestically and with a high percentage in California. Since the arrival of Mike McCook to run its real estate in 2001, it has begun to invest internationally.
At present the fund has a real estate weighting of around 6%, with a target of 8%. However, it has a great deal of flexibility: the strategic allocation is a range of 4-12%, allowing it to take advantage of market moves.
“For example, that flexibility allows us to do massive deals, like buying a public REIT and take it
private, something we have done three times in recent years,” says McCook. The flexibility, obtained through the sheer size of the CalPERS balance sheet, also allows it to sell down investments to take advantage of market movements. Due to the strong market for investment-grade properties in recent years, CalpPERS has been cashing in; selling $7bn of real estate since the end of last year.
“The markets have been a little frothy recently,” says McCook. “This makes it an ideal time to sell with interest rates and cap rates so low. Valuations are coming in higher than we would pay for assets so it makes sense for us to sell. I’m not saying it won’t work for other buyers, just not for us.”
The portfolio is divided into two parts. The core section, which at present accounts for 68% of the total, is invested in prime property in all sectors across the US both directly through separate account mandates and through REITs.
The non-core portfolio, 32% of the total, is invested in a wide range of ventures: unlisted funds, international property, distressed assets, timber and vineyards in California. CalPERS does invest in commercial mortgage-backed securities, but as a fixed-income investment, not through its real estate arm.
There is a still a strong bias towards assets in California, which make up around 35% of the total. “California has always been a strong performer in terms of US real estate,” says McCook. “It’s a market we know very well and has a range of different sub-markets throughout the state.”
At the moment, CalPERS is shifting its strategy from core to non-core and international real estate, as well as opportunistic ventures (both overseas and at home) are the beneficiaries. “Our crossover point between receipts and expenditure is coming in 2015-18, which is one reason for shifting the strategy away from core at the moment.” says McCook.
Internationally, CalPERS has committed to 16 funds in the past year and has around $1.2bn committed and as much in the pipeline. It has made a number of investments in European funds, including the Hines Western European Development Fund, IXIS-AEW’s France/Southern European fund and Fortress’s latest opportunity fund, which has a German focus.
“It’s been a bit of a challenge for a while to get money invested,” says McCook. “But again it helps to be a big player – we generally invest $100-400m in each fund we go for. The great range we have with our strategic allocation also means we can have a great deal of flexibility.”
Opportunistic ventures include a second technology/distressed assets fund with real estate broker CB Richard Ellis. The first venture, launched in 2000, bought out-of-favour data centres and other ‘technical real estate’ and has recently floated as a REIT, giving CalPERS the opportunity to take profits and still retain a stake.
Looking ahead McCook says:
“We have been in a wonderful
time for real estate, but we believe the fundamentals are still strong. However, a quick upward shift in interest rates could hit the market and of course bond and equity
markets will get strong again at some point. But we believe the
revaluation that has taken place
is a permanent shift.”

Esbjorn Wincent

Swedish insurance company Folksam has 8% allocated to real estate at the moment but head of real estate Esbjorn Wincent says: “We are just that little bit under-allocated at the moment and are planning to increase to 10%. We are looking for both interesting properties and indirect vehicles to invest in.”
While the 10% allocation is an immediate goal, new finance regulations will come into play in Sweden later this year and there will be new rules for life and pension companies, regarding solvency in these companies. The new rules will be presented in the autumn.
“We can see so far that there may be an effect, but it depends on how rich the companies are,” says Wincent. “It could affect the allocations funds have to stocks, bonds and real estate. There will be stress tests carried out for each company, so they will test what effect a 20% drop in the stock market for example would have on each company. We need to see what effect this will have on Folksam.”
However, he says, if the effect is
minimal Folksam will keep the 10% weighting in the long term, although
it could well range between eight
and 12%.
The geographic focus has changed, says Wincent. There is now a focus on major cities in Sweden and Folksam has also begun to look outside its home market and also to invest indirectly. This allows the company access to overseas markets but also to smaller markets across Sweden, which would not get in the direct portfolio.
A major recent investment has been Folksam’s allocation to Aberdeen Property Investor’s pan-European fund of funds, which has made its first investment and is planning five to eight in the next 18 months. Wincent says: “With this model, we follow a little bit of what we learned from the hedge funds business. We are in some ways a small investor so this vehicle gives us access to the market and a quicker way to achieve our goals of geographic and sector diversification. A fund of funds has greater negotiation power than the individual investors in that fund could have alone.” Will do co-investments or invest in single funds.
Like many other real estate investors worldwide. Folksam is pressured by the amount of competing capital for the asset class. “It has become really hard to find the right opportunities and the competition for those opportunities is getting stronger all the time, especially in the direct market,” he says. “An area such as Stockholm is very competitive and yields have fallen, and as a consequence the risk has increased, makes it more and more important to choose the right opportunity.”
However, as real estate is still a fairly small percentage of Folksam’s total assets, Wincent has a little more freedom than usual over the timing of investments. “We are not under pressure to get the money invested quickly,” he says.
In the direct market at home in Sweden, Folksam is still keen on Stockholm and the surround area, says Wincent. Through the fund of funds, the insurance company will be looking mainly at vehicles investing in Western Europe but also targeting central Europe.
Currently the portfolio is made up mainly (60%) of offices, 20% residential, 10% retail and 10% ‘other’ including industrial and logistics. Folksam is planning to increase the weighting of both retail and logistics properties at the expense of offices, where the weighing will decrease to 45-50% of the portfolio.
Wincent says Folksam’s real estate allocation will not include derivatives or CMBS at present and that he believes real estate equities are overvalued today.
He says the main risk to real estate investors in Europe is a rise in interest rates which could force debt-backed buyers to sell assets.