Passing fashion or timeless classic?
Investing in property is fashionable again but will it become a long-term trend? Property is proving to be a steady performer in an increasingly uncertain investment climate. At a time when the performance of international equity markets is so disappointing, it is hardly surprising that pension funds are broadening their asset allocation to include property.
In the early 1990s, the PGGM pension fund began cautiously to venture into indirect alongside direct property investment. In 1995 we took a strategic decision; we decided to shift completely from directly managed property to an indirectly managed property portfolio.
A number of factors influenced this decision, most importantly: the intensive management required for directly held property compared with the other investment categories; the need to grow the portfolio (about e3.45bn at that time); and to achieve diversification over international property markets and to improve liquidity and flexibility. When selecting property funds we consider country and sector-specific aspects to complement our existing portfolio. We do like focus – focus on currency regions and focus on sectors. Management and leverage are issues as well. Local management should manage investments and the management should be given maximum leverage limits.
We have learned from investing in indirectly held property. We would like to draw the attention of all those already investing indirectly or planning to shift (a part of) the property portfolio to some of the pitfalls:
q property characteristics are not widely available and there is a lack of transparency in property data;
q many characteristics of property investments are country-specific;
q attempts are being made internationally to achieve a higher level of harmonisation and so enhance standardisation;
q since only a minimum set of standards may be implemented over time supporting international deals and portfolios;
q the present draft requirements and standards1 under discussion apply only to direct property investments, the indirect property investments (listed or private) are governed by local standards, as will be the issue of gearing in regard to property holdings.
Since there is lack of transparency in property data, we do continuous research on property worldwide. This is not only to optimise the property portfolio, but also to provide a realistic view on property as an asset class.
It is for its specific characteristics that we see property as a separate asset class to which we very happily dedicate capital.
We carried out a second fundamental asset/liability management (ALM) review in 2000 to determine the ideal investment mix considering our future pension contributions and commitments. Our main consideration was the optimal correlation between the average risk-adjusted returns of the various asset categories. For a pension fund like PGGM, the main advantage of property is the capacity to lower the risk profile of the entire investment portfolio and the absence of any strong correlation between investments increases the return and reduces the risk. The outcome of our review was a 13% allocation to property and the positive net performance of around 10% a year helped to counterbalance the negative performance of equities since 2000.
We are now finalising our 2004/05 review. The analysis of the new review confirms the conclusions of the 2000 review.
Because of the improved transparency in the market and also to improve corporate governance, real estate is increasingly being regarded as a separate and worthwhile investment category by institutional investors. Since 2002, PGGM has sponsored the EPRA award for the best annual report in the sector as a means of encouraging greater transparency among listed European real estate funds. This prize was awarded for the second time in 2003 and was presented to British Land.
Attempts are being made internationally to achieve a higher level of harmonisation and so enhance standardisation. I would like to draw attention to the REIT status in this respect. With this status all profits can be obtained by an investor free of (corporate) taxes if at least the dividend distribution consists of the complete fiscal profit (subject to the investors own tax status and jurisdiction). Just because of this the important cash yield is kept at a high level. In the Netherlands we all know the FBI (Fiscale Beleggings Instelling), in Belgium there is the SICAV, and in France the SIIC structure. In the UK there is a strong lobbying campaign supported by sector, not only in the UK, but throughout the world.
Most pension funds evaluate property shares according to their share price, which can fluctuate in the short term, but PGGM looks at the net asset value (the intrinsic value) of the property itself. PGGM for its annual accounts has adopted modern accounting principles for a long time, which comprise of current value for the investments of the different asset classes. Actively managed stocks, bonds and alike are valued at their listed prices, while less liquid, non-listed assets such as private equity, strategic participations are being stated at the fair market value, mostly represented by the current value of the net asset of those entities, amended, to the extent necessary, in conformity with PGGM’s principles. The balance sheet represents those current values as the income statement represents the variations of these current values, as a consequence of periodic revaluations, and the net cash income of the assets on all inclusive basis.
Within this framework the property holdings, apart from the listed tactical part, are being valued at their current net asset value, for PGGM’s pro rata share, taking into account the fair value of the property. The respective property investments are stated at the estimated sales proceeds in a private deal, fully leased, between knowledgeable, willing parties. Properties under development are prudently carried at cost, amended for impairment if necessary.
Investments in majority holdings and minority holdings with significant influence are not being consolidated because of the sole purpose of providing funding and coverage of the pension liabilities.
We do not differentiate between listed and unlisted property companies but we do distinguish between strategic and tactical investments. Strategic holdings are for the long term, say five to 10 years. The main part of the portfolio, around 80, consists of substantial holdings in listed and non-listed entities with first class properties and management, substantially segmented over retail, offices, industrial and residential, as well as over different regions with significant economic power. Apart from that the property portfolio is composed of tactical assets. Tactical investments are held for a shorter period, used as swing asset in the rebalancing context and as a yield optimiser. Given their nature, these investments, unlike strategic holdings, are valued according to their stock exchange listing.
It may be said that PGGM is successful with property. Over the past eight years our property investments have achieved an average return of well over 10%.
Leon Muller is a senior portfolio strategist in the structured investments department of PGGM, the Dutch pension fund for the healthcare and social welfare sector. E-mail: firstname.lastname@example.org
(1) Refers to ongoing discussions at EIPC, EFFAS and GPS level