Moving mountains overnight
What do you see as the main challenges facing institutional investors?
The first challenge is to understand the true value of real estate. European markets are the last major markets in the world to undergo the yield compression that we have seen in other markets.
Good-quality real estate in the major markets in Europe is in very strong demand from global investors - real estate is no longer just a local play. Investors need to come to grips with the fact that the markets have globalised.
What we traditionally thought was the value of real estate may not necessarily be the value of the real estate now that we have global investors with different costs of capital.
There is a lot of money flowing into the pension schemes as an example, looking for an allocation to real estate. Investors are becoming more comfortable with the increasing transparency, level of disclosure and quality of management, and are therefore prepared to take a longer-term view of the asset class. They have access to more information so they can price it more accurately.
How large an information gap exists between where investors are and where they should be to gain full benefit from the market?
I think the big investors are there; they are savvy enough to know when the market is right for investment and when it is not. The smaller investors will continue to use third-party manager judgement a lot more than the bigger investors simply because they don't have the resources - and don't aspire to have the resources - to understand markets intimately.
What is your view of investor attitudes to gearing?
Europe has led the way with being comfortable with higher levels of gearing, followed by Asia. What has changed is the management of the debt: managers are far more prudent about managing interest rate risk.
Managers are now tending to swap out their interest rate risk to minimise the risk of interest rate fluctuations.
This helps in making investors more comfortable with using debt levels of 60%-plus. But on the whole real estate is an asset class that lends itself to relatively high (50% plus) levels of gearing.
Are there any cultural factors holding back real estate investing?
The biggest issue that we find in continental Europe is that in a marketplace which is so competitive there is a need to move very quickly in a transaction - but continental Europe is not known for things happening quickly. Being nimble is difficult for some of the larger institutional investors. Their peers in the US, for example, can move mountains overnight.
To some degree, this stems from the historical lack of reliable information flow and transparency in local markets, which naturally makes investors more cautious than they would be otherwise. But as this information flow improves and becomes more reliable, and more global investors enter the markets here, local institutional investors are moving far more quickly than they were two years ago, for example.
What other key developments would you like to highlight?
A dynamic which will have a big impact will be the meeting of the capital markets and the real estate markets. As the shift from defined benefit pension schemes to defined contribution schemes continues to gather pace, demand for income-focused investment vehicles continues to increase. And with governments now legislating to allow for greater tax efficiency in REITs, the stage is set for REITs to grow in size and number. The emergence of REITs in Europe will probably be the greatest catalyst in making markets far more efficient. In addition, real estate is an asset class that is fundamentally illiquid and any developments in the market that improve liquidity should be seen as a good thing
Another key development is that investors are getting more comfortable with investing in the Asian markets. Asia is a long way from Europe and these markets have traditionally been a little volatile but investors are now selectively going into these markets. This is very encouraging.
The growth of the real estate debt market in Europe is another positive trend. We have seen it happen in the US where the CMBS market is huge.
Europe is set to grow to similar levels, if not larger, as the number of real estate vehicles grow and they issue debt to the public markets. As REITs and funds emerge, they will look for the most efficient forms of debt either from the private market or the capital markets through CMBS. We think the growth of CMBS in Europe will be significant.
Why has it taken Europe longer to develop in this area?
Europe hasn't had a mature listed real estate market and a listed debt market really follows the equity market, so it is a natural progression. The capital markets in Europe and the real estate markets in Europe are only just meeting - hopefully they will get married!
In addition the derivatives market is getting a lot of attention both here and in the US; I would go as far as to say that the market is more developed here in Europe than in the US at this point.
Are you happy with the way REITs have been structured? Are any of the REIT markets sub-optimal in any respect?
The key is tax transparency: for a REIT market to be successful and grow, investors should only be taxed once and not twice. Paying tax at the entity level and then at the individual level will definitely stymie the growth of the REIT industry.
The UK seems to have got it right - there may be further changes as they fine-tune the system. The situation in Germany, Italy and France is getting there. While some fine-tuning is still required, all have taken a quantum leap from where they were two years ago.
Are you concerned about the variable quality of real estate indices? Will this hold back the development of real estate derivatives?
The indices will continue to improve in their size and transparency because of the growth of the listed market which will improve levels of disclosure, but this will not happen overnight.
We think that over the next five to ten years derivatives will become very big for real estate. When you step back and look at the real estate market you see that it is the only asset class that doesn't have a derivatives market wrapped around it, so logic tells you that this will come, especially as the levels of disclosure improve.
Which of the new asset classes do you consider most promising?
Another encouraging development has been the emergence of infrastructure; we think there is a big market in Europe which will develop further. Governments here and around the world are struggling to maintain their infrastructure and they are ultimately looking to the private sector to invest by wrapping investment vehicles around it. This makes sense and provides inflation-proof investments which are very attractive for investors.
Infrastructure should be an investment for all seasons because of the long-term nature of concessions and inflation-proof nature of the income stream. Real estate is not dissimilar and also a little more liquid.
We also think real estate catering to the ageing demographic, such as seniors' accommodation and healthcare to be very promising. There is increasing demand - underpinned by the demographic trends and growth in the over-50s.
With the dramatic improvements in medical technology and nutrition, people are living longer- in fact it's not unreasonable to think that our children are likely to live beyond 100 - this will have quite an impact on society and accommodation needs. We think seniors' accommodation is going to be a big part of the real estate landscape in coming years.
Do you agree that healthcare and some of the other newer asset classes demand much more focus on the management of the operations as opposed to the underlying real estate?
e are increasingly finding that the operators get a good return from the real estate but they get a much better return when they invest in new equipment and more beds. So if they can marry themselves to a long term reputable owner of the real estate with a long-term leaseback it's a win-win situation. This is a big trend.
Are more investors bringing up the issue of alignment of interests and are you and other managers having to adapt to this concern?
Yes. The market is certainly moving to a lower base fee and is embracing performance fees - I think this is logical. As far as the alignment of interests is concerned, we invest in every fund with our investors so we suffer the same consequences, which I think is the perfect alignment. We are also finding that investors are demanding that the key people involved in the management of the fund also have a stake in the performance of the fund.
Are the minimum levels of investment an issue in terms of investors accessing real estate?
Absolutely. The trend we are seeing is that the minimum investment levels are decreasing. I think this is sensible as it opens up a new tier of investor. Administratively, managers will need to adapt but in reality it is not that much more work. I think you will see this happen very quickly in this market.
Will derivatives become the preferred tool for small investors?
Yes, Iwould agree that where investors can't take a meaningful position in a fund or can't own real estate outright they would probably enhance their real estate portfolio by taking a position such as a swap which would give them broader exposure than they would otherwise be able to get.
Consultants in Europe tend to advise their clients to be cautious about venturing into Asia. What is your view?
ou definitely need to be cautious when entering Asia. There are some compelling investment opportunities in Asia, but the key remains to align with a reputable and local management group.
Where will European institutional investors be in five years' time?
My guess is that in five years the list of major global investors will include more European based investors than it does now. I suspect they will all have a big presence in Asia including India, and could well rival some of their US peers as the EU continues to expand.