Dutch experts question effectiveness of property as inflation hedge
NETHERLANDS - At a meeting to celebrate the fifteenth anniversary of IVBN - the Dutch association on institutional property investors - experts yesterday called into question many pension funds' assumption that real estate investments help offset inflation.
Johan van der Ende, outgoing CIO of Dutch pensions manager PGGM, said: "Property offers diversification advantages and relatively higher, stable cash returns. "But in the longer term, property investments do not actually offer a very good inflation hedge."
PGGM has no direct property holdings. Indirectly, it invests €6bn in private non-listed property and €7bn in public property.
Dutch pension funds on average allocate 10% to property and often mention inflation protection as an important motivation to invest in real estate.
But the actual hedge against inflation is "disappointing", said Van der Ende.
"Although rent income rises with inflation, the value of the property itself does not," he said. "Just look at what happened in the US recently, where property values plunged despite inflation."
He added that the same held true for index-linked bonds. To use property as inflation protection, there is only solution, he said: "Pension funds will have to take the risk necessary to generate returns."
Peter van Gool, professor of real estate economics at the University of Amsterdam and managing director of real estate at SPF Beheer, the pensions manager of the Dutch Railway fund, agreed.
"In an ideal world, property would provide positive and stable returns in bad times as well as good times, good liquidity and a hedge against inflation," he said. "The reality, however, does not conform to the ideal."
According to van Gool, direct property investments offer the best characteristics in terms of low correlation to other asset classes and returns that are stable, if not spectacular.
"Direct real estate helps even out shocks, smoothing out the peaks and troughs of other asset categories," he said.
"If pension funds would have had an allocation of 30% to direct property as at end of 2006, their funding ratios would never have dipped below the critical threshold of 105%, as they have done now."
More than 90% of the assembled real estate managers and investors voted in favour of a suggestion that pension funds should raise their allocation to property from the current average 10% to 15%.
However, Van Gool warned that the trend in the Dutch institutional market was to move away from direct holdings in favour of indirect listed and non-listed real estate - categories he said had disappointed, "particularly in the case of non-listed property, which was heavily leveraged".
Regarding the use of leverage, 54.7% of the audience of property experts preferred a maximum leverage of 30%, while an additional 27.6% suggested that no, or hardly any, leverage should be used.