Bricks and mortar have long been a foundation in the institutional investor’s portfolio, yet in a world where appetite for inflation-linked assets is insatiable, property has a new role to play.
“Investors are investing in something that, assuming they have the right property and the right tenant, will provide 25 years of inflation proofed income which is exactly the sort of thing most pension funds a
Greg Wright
Commercial real estate investment has always offered some inflation matching characteristics, since growth is reliant on job creation and GDP growth. As businesses become more profitable and employ more people so they need more workspace and will pay more rent.
“That is inflation linkage,” says Marcus Sperber, managing director and head of Blackrock’s international real estate business. “But we would never say that property can match inflation absolutely.”
Yet a new breed of property offerings from investment managers offer a much closer match to inflation than traditional real estate holdings.
These long lease property funds have rental increases linked to RPI – or indeed any preferred inflationary measure – and are fixed for a lengthy period, usually around 25 years. The result is investors can be pretty sure they have an income stream that will climb in line with their own liabilities’ inflation exposure. Sperber says long lease property funds are still not a complete hedge, but they are “a good way to match out [institutional investors’] requirements against inflation.”
Built-in benefits
The £5.5bn Pensions Trust is an advocate of long lease property investment. The scheme, which is responsible for nearly 2500 charities’ pension funds, has £78m invested in long lease funds with Standard Life, amounting to around 2% of the overall fund.
With more than three-quarters of The Pensions Trust’s liabilities linked to inflation, any assets which proffer matching characteristics are of interest to David Adkins, the scheme’s chief investment officer.
Adkins says: “We like the fact that a significant part of the properties we own have rental agreements with auto inflation increases built in. About 40% of the long lease portfolio has that element included.”
Consultant KPMG has been raving about long lease property funds for well over a year. In 2012 the firm put out a report claiming long lease property funds should be the default real estate investment choice for pension funds, arguing they were a far better choice than traditional balanced funds.
Greg Wright, head of property research at KPMG Investment Advisory, says alongside the more formalised inflation linkage offered by long lease funds, they also have a longer term horizon, meaning pension funds are not forced to keep switching their investments every few years.
“Leases aren’t set at six or seven years; they are 20-25 years. Investors are investing in something that, assuming they have the right property and the right tenant, will provide 25 years of inflation proofed income which is exactly the sort of thing most pension funds are looking for,” Wright says.
Wright’s enthusiasm does not end there. He notes that while long lease funds are not as perfectly matched to inflation as index-linked gilts, they certainly offer a better rate.
“Investors are getting [inflation linkage] at a yield that is higher than government bonds. It’s a good yield and its income linked, it’s also secure and not something you have to trade very often,” he says.
It seems KPMG clients agree. Wright says for every £1 of his clients’ money going in to balanced property funds, £10 has gone into long lease. Of course, this may not be replicated across the institutional investment board, but Wright says demand is there.
Strong appetite
“There is a lot of appetite [ for long lease funds]. £4-5bn has been invested already, which has grown from nothing over 10 years. This might be a small amount compared to the total in balanced property funds but long lease has been higher in terms of new money coming in,” Wright says.
As of 2012, the market has averaged growth of 30% a year since the end of 2004, reflecting investment performance but also impressive asset inflows. KPMG predicts this trend will continue, which is already being evidenced by activity in the fund management market this year.
Axa Real Estate, the property arm of Axa Investment Managers, announced the first acquisitions to its long lease property fund at the start of 2013, while Blackrock revealed the addition of six new pension fund investors to its long lease offering in July this year.
Finding the right match
Getting into the long lease market is not necessarily easy, however. Finding the right properties and the most reliable tenants are critical elements to success.
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