Are institutions building for the future?
How big is the current market for institutional real estate investment in Europe? And just how much potential is out there for increased allocations by pension funds to the asset class? These are two questions that will be familiar to any real estate asset managers that have sat down and scratched their heads trying to figure out the complex and disparate European institutional scene.
The story is out that European pension funds are looking to raise their property exposure after three years of being brow-beaten at the hands of the equity markets, at a time when property was returning some of its most respectable performance figures.
In addition, investment manager commissioned research has suggested that pension funds should today be investing up to 15% of their assets in real estate. With these two major opening questions in mind, IPE Real Estate addressed a unique survey directly to the European pension fund readership of Investment & Pensions Europe magazine, inviting them to outline their current allocations in real estate (percentage of total investment allocation, geographical breakdown, direct/indirect etc), to say how these allocations to the asset class had changed over time and to predict where they would be going in the future.
The response to the survey was strong, with replies from pension funds from the UK to the Czech Republic and all points in between – representing total assets of some e100bn (75% of responding pension funds gave their AUM figures, which represented e93.4bn in assets).
The country breakdown of respondents will come as no surprise to those intimate with the European institutional property market.
Of those pension funds that gave their country of origin, 30% were from the UK, 13% came from the Netherlands, 10% were Swiss, while 7% were from the Nordic region (mainly Denmark and Finland). The remaining 40% of respondents represented funds from across the continent, including institutions in Ireland, Italy, France, Belgium, Austria, Czech Republic, Hungary and Slovenia.
The questions asked of Europe’s pension funds were as follows:
1. What is your weighting to real estate as a percentage in your current asset allocation mix?
On average this came out at a credible 8.4% in real estate, albeit ranging from respondents with no property in their portfolios to other funds with 30% in some form of real estate investment.
The range of responses suggests a large disparity in the way the asset class is viewed by institutions around Europe.
While UK institutions made up the biggest single group of respondents, they were far from being the heaviest allocators to property. A good number of Finnish, Swiss and Dutch plans said they held significantly more assets than their British peers – perhaps unsurprising bearing in mind the continued large exposures to equities amongst UK pension schemes.
Extrapolating this 8.4% average allocation figure of respondents to the IPE Real Estate survey would give a total of e7.8bn in property (a number that would have been higher if all funds had given their AUM figures). This would come out to an average of e211m in property per pension fund, although the disparity in allocations between schemes has to be recalled here.
2. Has this allocation increased/decreased in the past one, three, five or 10 years?
Over one year: A common footnote to this question was that while many pension funds have not taken particular steps to commit money to property in the past few years, their asset mix has been ratcheted up in favour of real estate due to the poor state of the equity markets. To this extent many pension funds expect real estate exposure to fall back a bit on the back of an equity market recovery.
However, a number of funds also noted that they had been divesting from property in the last year or so.
Over one year, half of the respondents (50% exactly) to the question said their allocations had risen, while 45% said exposure had fallen – perhaps reflecting this disparity in views.
Nonetheless, the shifts in allocation either way tended to be in the 1–2% bracket, suggesting this is more likely a result of portfolio balancing than any major tactical decisions.
Over three years: Responses came out at 100% increased allocations to property ranging from small jumps of 0.5% of allocation to larger shifts of up to 5%, suggesting a mix of rebalancing and strategic moves mirroring the equity market crash.
Over five years: 60% of respondents posited a rise, but again with a much wider range, from just 1% of assets to a sizeable 14%.
Similarly, the 40% of funds that reduced their allocations recorded a wide range of divestment: from small decreases of just 1% against large sell offs of up to 10%.
Over 10 years: Again over the longer-term many more pension funds have been increasing allocations to real estate with 70% of respondents saying real estate had risen by between 2 to 13%.
Just under a third of funds, however, said their exposure to property had decreased heavily over 10 years – ranging from 1.6% to 25%, although the latter drop in one fund was explained by a very large historical allocation to real estate.
3. Do you expect your level of real estate exposure to rise?
54% said yes they did expect their allocations to real estate to rise, against 46% who believed that it would either remain stable or fall.
It should be noted, however, that many pension funds that predicted a ‘rise’ in allocation had held no real estate to date and that many of those funds envisaging ‘no rise’ already hold significant levels of real estate in their portfolios.
Those that have a sizeable real estate exposure in their portfolios seem to be fairly pleased with it though, particularly one fund with a current 23% allocation that said it still expected this figure to rise.
4. If yes, what do you expect would be your maximum allocation to real estate as a percentage of the total investment portfolio?
Those pension funds responding in the affirmative said that on average they expected their allocation would rise to 11.7%.
If you compared this figure to the average current holding of 8.4% for respondents to the survey then this would represent a significant jump in assets.
However, we did not question those pension funds that expected to lower their allocations on how low this could drop.
5. How much of your real estate exposure is the allocation to your:
Domestic market: 89.9%
68% of pension funds replied that they had real estate exposure to their domestic market and that on average this represented an incredible 89.9% of their overall property investment – a sure-fire indication that the cross-border market for real estate has some way to go before it can be compared to international investment in bonds and equities.
43% of funds replied that they had exposure to Europe and this represented on average 30.6% of their allocations.
Less than a fifth of the respondents (16.2%) to the IPE Real Estate survey said they had any exposure to the US. When they did, however, their allocations were not insignificant, showing an average 21.7% allocation.
Asia is still very much off the real estate radar, it seems, for European pension funds with only 5% of responding funds investing there, albeit it with allocations of 10% on average.
6. How much as a percentage of your total real estate exposure is:
Direct: 54% of funds said they had direct real estate exposure representing on average a very high 88.05% of their exposure to the asset class. Those pension funds it seems who go direct like to have as much as they can in a portfolio of owned buildings rather than any fund arrangement.
Indirect (ie via investment funds): Interestingly, while more pension funds (65%) responded saying that they used indirect fund vehicles (solely or in addition to direct) for real estate, they were much less bullish in their allocations, placing on average just 55.8% with a fund.
The overall impression is that European pension funds still like their real estate direct but that many are trying the indirect route to see how that performs.
As one fund commented, direct investment in real estate can be inappropriate for some schemes: “Direct is not deemed a sensible option for a fund like ours, where liquidity is an issue because we are a highly mature defined benefit plan.”
7. What do you feel are the benefits of investing in real estate?
This was a rather open-ended question trying to gauge how institutions see the value of real estate in their portfolios.
53% of respondents stated that diversification across asset classes was a firm reason for investing, while the same number mentioned either stable or attractive returns and good dividend streams - with many noting that real estate returns were often greater than for fixed income.
A further 13% mentioned the low correlation of real estate with other asset classes, while 17% said property acted as a useful hedge against inflation.
As one pension fund manager commented: “It is a balancing thing in our portfolio. You can foresee a certain yield for real estate for a year or two and you will get it.”
Others were keen to point out that property was a ‘real’ long-term asset for pension funds: “Real estate has low volatility and is a real asset with predictable cash flow and interesting returns compared to other asset classes in recent years.”
Another manager added: “Since most real estate companies are listed on the stock market they may benefit from equity markets going up, but if markets go down collectively they don’t go down as much since investors appreciate the ‘tangible assets’ as a good guarantee.”
Another respondent mentioned that as a pension fund they develop so-called ‘brown field’ sites, which had a social function, providing “economic regeneration and jobs”.
Just one respondent said it could see “no benefit” from investing in real estate.
8. Are there any issues that you believe need to be addressed by the real estate industry that might encourage pension funds to invest more in real estate?
Again, we were seeking to elicit some guidance from institutional investors as to how real estate might become more palatable to them from an investment perspective.
Unsurprisingly, 41% of respondents pointed to liquidity as their key concern regarding property.
“Liquidity is the major drawback in property investment since timing of entry/exit is the key variable. If this could be controlled so as to enable a sharing of growth missed or falls experienced this would help,” commented one respondent.
35% flagged up transparency issues as a potential block to further investment. Included under the transparency banner were many sub-comments on issues, such as benchmarking and performance measurement, long recognised as problematic by the real estate industry.
According to one pension fund chief: “We need greater standardisation/rationalisation of indices to enable better benchmarking. There also need to be reduced delays in index publication.”
The other main complaint by pension fund managers was that old bugbear of ‘costs’, with both the expense of investing in real estate as well as the issue of undisclosed costs being raised.
However, one pension fund manager argued that the latter was only an issue for smaller schemes: “There are no structural reasons why large schemes should not invest in real estate. Costs and difficulties in constructing a diversified portfolio are issues for smaller schemes only.”
Another manager felt the main problem was in finding suitable managers to invest with outside the scheme’s home market (perhaps explaining the preference for domestic investment in question 5): “The largest problem investing outside your domestic market is to find honest people with local insight to co-operate with!”
One peer suggested Europe had work to do in making the asset class efficient: “In the US this is a very liquid efficient asset class. In Europe it is still a struggle (although much improved) and the correlations (which are too high) show it. In Asia it is even worse, but in Europe it would be very helpful, for example, to introduce REITs in the UK.”