Going after the opportunities
By virtue of its size and presence in the global real estate market, you could be forgiven for thinking that ABP, the giant Dutch pension fund, had been invested in international property since time immemorial. The reality, however, is much more recent. Until 1987 the fund was not allowed to invest in real estate outside its domestic market, and, when it did, only a small portion of its property assets was invested overseas.
From 1987 onwards, however, international allocations to property became somewhat obligatory for ABP because the fund was still limited under Dutch law to majority allocations in fixed income and small portions in equity.
Jelle Mensonides, CIO, alternative investments at ABP in Amsterdam, explains that when the fund began in the mid-1990s to produce regular ALM studies the strategic target for real estate came out at approximately 10% of the overall portfolio, where it remains.
“In the early 1990s we had started to look away from just investing directly in real estate in the Netherlands for diversification reasons and the fact that we were just too big for the market.
“Then, for organisational reasons, we got rid of direct investment activities within ABP and created our own wholly owned funds for residential [Vesteda, which as a listed fund attracted other shareholders as_well], office fund KFN and retail [WFN, later merged with the listed fund VIB in to the listed RE fund_Corio].
“This was done to separate the roles of operator and investor. We didn’t want to have internal people looking at the bricks and mortar end of real estate, because we had other return goals.” At the same time, Mensonides notes that ABP began intensifying work on overseas real estate investment, with a target to invest about 30% in the US market with additional small portions in Asia and Australia and the remaining bulk allocation in Europe.
Today, the fund’s historic strategy of property investment in the Netherlands has been rewritten to become a global approach with two teams, one in the US and the other in Amsterdam.
Barden Gale, New York-based co-CIO of the global ABP Real Estate team and head of North American property investment, says that while the lion’s share of ABP’s US exposure is in listed REITS, the fund also invests in private unlisted funds and companies and joint ventures.
“Before I arrived at ABP in 1998 there was already a migration from direct listed to indirect non-listed. If there are opportunities we will pursue them whether they are listed or unlisted.”
However, as Gale points out, tax issues regarding US private investments make them particularly difficult to access for foreign investors: “If ABP owns more than 49% of an asset then it materially increases its taxation liability. If we invest in securities there are fewer issues as long as we don’t control the company. As a minority shareholder in a REIT then there is no real tax issue for us.
“This means that, on the private side, where we’ve started to do a bit more investing, we’re restricted on the amount of ownership we can take. The returns outweigh the increased taxes in certain cases, but that’s a rarity.”
To this end, ABP’s strategy in the private market has been to focus on investing via comingled, typically closed-end funds.
“We have also made two investments in private companies – one of which we’ve already sold. Additionally, we’ve now begun a programme of joint ventures, one of which was announced recently with Prentis Properties, a major REIT here in the US. Prentis put up 51% of the capital and we put up 49%.”
In the US, ABP also created an income-oriented approach to investing, using its experience in public real estate to start investing up and down the capital structure of the companies in which it already owned common equity. “Here we are trading on our strength as an equity investor not a debt investor, so, for example, we would invest in below investment-grade CMBS [commercial mortgage-backed_securities], whereas the fixed income side of ABP has its focus on ‘normal’ fixed income assets. If there is real estate corporate debt available below BBB then we will look at investing in that as well.
“We have had a very substantial portfolio of such instruments in the last 18 months, via a portfolio of preferreds, convertibles, equities and bonds, strips of CDOs and mezzanine debt (invested via ABP’s only external real estate mandate), and below investment-grade CMBS.”
Gale says the reason for going down this route is a question of “higher risk-adjusted returns”. “It came down to two things we identified. The first was that the securities were mispriced. About two years ago this was certainly the case and if you talk about the spread compared to corporate bonds or whatever your risk-free reference rate is, then the spreads were abnormally high – especially going into a low-growth environment.
“Secondly, why were they inefficiently priced? Because not a lot of people had the ability to underwrite these securities: they don’t know the companies or the securities, whereas we were able to do both. On an annualised basis there was a substantial amount of outperformance from this approach.”
Adds Mensonides: “We have a huge REIT portfolio, but the skill sets we can exploit apply to much wider investment universe including direct and mezzanine, etc.
“Normally you see a lot of investors focusing on their own benchmarks and everything that falls outside of that is neglected. For a knowledgeable investor it is really attractive to invest beyond its benchmark companies and securities because there is a wide spread or a nice premium to be gained.”
Such strategies form part of a wider move by ABP, says Mensonides, to equalise its current 60% exposure in listed activities/ 40% in unlisted to a 50/50 balance in the US in the next couple of years.
“The idea behind that is that we see a relatively high correlation between listed real estate and equities. So to get a better perspective from an asset liability view we are now seeking returns from unlisted investments. We are using private equity vehicles and participating in funds where the operator is in charge of day-to-day activities and we are just the limited partner investor.”
Looking at the US real estate market today, Gale believes that many of the important issues are not all that different from Europe.
“There’s a scarcity of good risk-adjusted returns. Whether it’s the German funds investing in Europe and the US or the Australians in the US for their LPT listed property_trusts market, they’re both buying up risk at very aggressive prices.
“Those are difficult things for an experienced institutional investor to confront. However, there are always things that that kind of money can’t and won’t invest in.”
Consequently, Gale says ABP is focusing on niche opportunities (see box) in both the US and Europe and “waiting for the capital markets to correct themselves somewhat”.
“This may or may not happen, in which case we’ve reached a secular change in pricing, which you have to accept.
“There are opportunities and we are still doing business as usual, but we being very cautious, however, on investing in plain vanilla, fully occupied real estate – whether it’s indirectly or directly.
“You might be able to do that in central Europe in some of the secondary cities, or in the US in an off market area, but then again we are not direct investors, so we look to our REIT or fund manager to avail themselves of those opportunities.”
Regarding issues that ABP has to consider when investing overseas, Mensonides notes that currency fluctuation (a moot point for the US) is a factor that ABP has to manage for equities and bonds also, meaning it is looked at on a global basis within ABP.
“We have decided to hedge our US exposure 100% at the moment, for example. This is not a long-term hedge and we can deviate from time to time.” In Europe, ABP’s real estate exposure is around e1.9bn, while in Asia and Australia the fund has property assets of some e800m.
In contrast to the US, ABP’s European focus is less on listed securities and more on direct investments, due to the relative dearth of the former on the continent – despite recent, increased REIT-type developments in line with the US.
However, Mensonides explains that the fund’s focus in Europe is on transparency and the use of a sector and country approach. “We look for operators who are first class in their activities, whether it is in office or retail, and we team up with a number of other investors to negotiate the terms. So far this has worked well.
“Our portfolio managers also work closely with their counterparts in New York and we have an internal screening process where we try to get a global approach. This works well also, although we have number of areas to develop. I see this process as a major focus for how we work in the coming years.”
For the Far East, ABP has listed real estate exposure in Japan and the developed Asian markets, as well as in Australia. Last year, the fund decided to emphasise Australia, especially Australian LPT exposure .
“From an allocation point of view the LPT is very attractive due to the high yield, which you also see in REITS in the US and the real estate companies in the Netherlands and France. France has recently changed its tax systems to improve the attractiveness of listed property vehicles.
Regarding Asia and Japan, Mensonides says ABP has a “longer-term focus”, due to the fact that cash yields are often lower than in Australia and other parts of the world.
“Japan is starting its JREITS so it is becoming more comparable with other countries, but transparency is still a problem there.
“What you see in Hong Kong and Singapore is that real estate companies are often large conglomerates with other activities, which makes things, from a real estate perspective, more complicated.
“In the longer term though I think China could be a challenging area, but you need to be very careful because of transparency and ownership issues. It’s developing quite fast so you have to take that into account.” ABP does not yet invest in China.
Another area where Mensonides sees significant potential for institutional real estate is in the development of derivatives for the asset class – a fledgling market already.
“By introducing derivatives you create liquidity for all parties so that is certainly a theme for the future.”
For Gale, such developments indicate a wholesale re-evaluation of real estate by investors – both institutional and retail.
“Investors are beginning to realise that real estate is an investment with a lot of potential, be they plan sponsors or people investing self-directed retirement funds.
“The ability to understand and invest in real estate funds and companies through accessible information and a better regulated capital environment has improved immeasurably.”