FEATURE: Long Play

Investors still want real estate in the portfolio for the same reasons as they wanted it before the credit crunch. PERE magazine December 2009-January 2010 issue

It has been a topsy-turvy year for institutional investors, to put it mildly. Headaches with steep write-downs gave way to valuation increases necessitated by rising global equities. Now, suddenly, over just the past few weeks, limited partners seem able and in some cases desperate to invest in real estate again.

In the UK, one GP who did not wish to be named, told PERE that he knows of a British institutional investor that needs to put £500 million to work in property … immediately. 

Long play for
real estate

Claude Angeloz, co-head of the private real estate team at Swiss-based alternative firm Partners Group, adds: “Investors have really come back in a big way. They are all coming out at the same time wanting client meetings and projects.”

Angeloz explains the phenomenon as partly the result of investors putting aside a lot in cash after the collapse of Lehman Brothers last year.

The cash pile was amassed by selling equities and bonds. Now that equities have made gains, they find it no longer makes sense to hoard so much cash, earning next to nothing in a low interest rate environment. This is especially the case for insurance companies and pension funds, which in some cases have regulatory requirements to generate a minimum return in order to meet liabilities. “Zero return is not enough. They are under pressure to start showing positive performance again,” remarks Angeloz.

Growing into real estate

There are certainly some institutions which are currently looking to property to outperform other asset classes, and therefore view real estate as a growth play. That said, the more common reasons why investors seem to continue to put property in their baskets have survived the credit crunch.

For example, LPs continue to need diversification. A survey over the summer of UK pension funds by London-based global real estate investment manager PRUPIM and the UK pension body, the Pensions Management Institute (PMI), concluded that the majority of investors will maintain or increase their allocation to property over the next three years. The research suggested pension funds still value diversification and the relatively steady and occasionally high returns that real estate can offer as an asset class.

What investors globally have found is that while some markets tanked in the wake of the financial crisis – including in the UK – the value of property assets in other countries remained relatively stable. Examples include Germany where investors witnessed negative returns, but nowhere near the falls seen elsewhere. The same can be said for emerging markets such as India or China.

Many investors seem to be underweight in alternative assets generally, which suggests renewed inflows into real estate. The Blackstone Group’s chief executive Stephen Schwarzman said during a November conference call that he expected investors from Asia, the Middle East and Europe to increase their alternative asset appetites. He said the shift away from North America is because those in other regions are “going to be increasing their percentage [of allocations] to alternatives and at a faster rate because they’re under-allocated at the moment.”

Under or over-weighted?

Schwarzman’s comments seem to be more than wishful thinking – many investment advisors agree with his under-allocation comments. Kirstin Irvine, a European real estate researcher at global consultancy Mercer, says the firm is advising UK clients to reverse a five-year policy of being under-allocated to property.

“We have been recommending that clients move back to their long-term strategic weighting and become overweight in real estate on a tactical basis at the moment,” she explains. There are four reasons for this overweighting: diversification, inflation hedging, high income and continued attractive risk return ratio compared to other asset classes.

This advice – imparted earlier in the year – is now being acted upon. That adds credence to the anecdote about an unnamed group’s need to put £500 million to work.

Indications that real estate is in demand among institutional investors does not necessarily spell good news for all asset managers. One set of losers might possibly be opportunity funds. This is because many investors currently prefer strategies that do not contain high leverage or provide less investment risks to worry about.

Core is the new opportunity

Partners Group’s Angeloz says investors are looking for solid “core-type” assets in good locations with solid

The risk people are willing to take today is where the quality assets have broken balance sheets, for example where a property has originally been financed aggressively so that the existing owner can no longer hold on due to liquidity constraints.

Claude Angeloz, co-head of private real estate, Partners Group

occupancy that generate income. “The risk people are willing to take today is where the quality assets have broken balance sheets, for example where a property has originally been financed aggressively so that the existing owner can no longer hold on due to liquidity constraints,” he explains. “There is a lot of demand for recapitalisations of real estate assets, and even for entire property funds.”

However, the generally under-weight position of investors to real estate and the survival of traditional reasons to invest in the asset fails to spell relief for LPs who need to downsize their investments in real estate, specifically their indirect holdings.

These investors heavily backed mega funds of the 2006 and 2007 vintages, but do not have the resources or desire to meet capital calls. A continued decline in the NAV of investment portfolios has sapped LPs desire to hold these indirect assets, explain experts.

Hence, there is a wave of secondary interests in the market. The volume has grown massively. Partners Group says the secondary market has mushroomed to more than $13 billion of interests on the market so far this year compared to $3.6 billion last year. Potentially elevating this figure even higher is another major divestment transaction expected to be announced as PERE went to press.

Nevertheless, the more powerful trend will be anxious capital waiting to get into the real estate asset class, not the other way around.

The $34 billion Alaska Permanent Fund Corporation, which has a current real estate allocation of 10 percent, just below its 12 percent target, is a typical investor. The denominator effect has worn off, and now it is looking to the asset class for income, an inflation hedge and a little bit of growth. Chief executive Michael Burns said of real estate: “I think there will be some growth opportunities, but over the long term it is about having stable assets that provide income rather than growth.” 


Ric Lewis, Founder,
Tristan Capital Partners, London

Tristan Capital Partners’ founder Ric Lewis says: “The price of core assets is already improving. We think


that a window will start to re-open for “core-plus” investing in 2010. We also think that this window may prove to be both durable and highly lucrative for investors, as lower rates of growth and leasing pace will be combined with opportunities to make repeated investments in assets that require asset management at historically low prices.”

“Defining investment strategies by reference to asset quality is, as ever, a challenge. Property investors are particularly notorious for using financial terminology loosely. Some start with ‘core’ and work down, others start with ‘value added’ and work up. We have always started with ‘core-plus’. Take a good building in an economically sensible spot in a major urban location. Assume it is either fully leased with some near-term rollover, or small degree of vacancy. Add some modest leverage and perhaps a touch of light refurbishment. If you are offered a 200 basis point premium, then voilà, it is core-plus.”

Christophe de Taurines, Founder,
Capital & Marketing, London

Christophe de Taurines, whose firm raises capital for alternative asset funds, says: “Overall, real estate will

de Taurines

remain one of the largest allocations in the portfolio for institutional investors. Allocations are 5 percent to 10 percent for insurance companies and 15 percent to 30 percent for pension funds, and that has not changed. If anything, real estate is being confirmed as a major asset class. The reason is that it has proven to be a fairly stable asset class for these investors. The role of real estate in the portfolio now is to provide stability of cash flow, an inflation hedge over time, and also some form of growth.”

De Taurines was in Switzerland last month meeting Swiss pension funds which own direct investments in
Swiss real estate. He notes that their direct assets – including Swiss residential property – have held value. In contrast, some of the funds they invested have shown a greater volatility and propensity to have negative values. “Because of that data, a lot of institutional investors are wondering if they are going in the right direction. There is a greater scrutiny of the manager and risk profile of real estate funds. The only thing, though, is that a number of core funds have actually performed less well than a number of opportunity funds, with minus 60 percent or minus de Taurines: stable asset 70 percent growth.”