What is the outlook for property investment, and how is demand shaping up?

Barry Fowler: We are still finding opportunities, but it is a more challenging marketplace. I think it would be fair to say that local authorities in particular have been competing quite considerably in that space, because they have access to their own particularly efficient form of funding at the moment.

What we are fundamentally basing our investment strategy on is the strength of the underlying tenant.

As a pension fund, you are looking long‑term to cash flows, you are not looking to short‑term liquidity

Gerald Wellesley, HR Trustees

Now, of course we will look at where the rental levels are, how affordable, what happens if the tenant was to fall over, could we re-let, etc.? The way some of these deals work is that they can be structured at below market rent levels, but with either fixed annual increases in rent or being subject to indexation.

Pensions Expert: Are many schemes looking at property?

Gerald Wellesley: It is an increasing trend with schemes. Several consultants are out there drawing attention to the fact that, at the end of the day, it is about paying pensions and how well-hedged your liabilities are. It is a big trend for schemes to start looking at cash flow as they get more mature, as a means to hedge against their outgoings.

Obviously the record low gilt yields have come up slightly since the Brexit vote, but they are still rock bottom in historical terms, and I think people feel that there is an asymmetrical risk, the chances of further falls are smaller than the rises, and therefore an effective hedge is to look for some kind of inflation-linked investment.

And, as a pension fund, you are looking long-term to cash flows, you are not looking to short-term liquidity. If you have good-quality underlying tenants to produce that cash flow, that is very attractive now to pension funds.

Of course, a lot of structures are layered, so you would not necessarily put all your eggs in one basket, but you would layer different kinds of assets to produce an effective way to manage your liabilities.

Danny Vassiliades: Property has been used for a long time as an alternative to equities, but there is more stuff around now competing in that particular space. If we go back 20-30 years, property was the main one. Pension funds still like property because it is well understood and it is very investible.

But you do have this liquidity constraint with property funds, and there have been several examples in the past few years of having delays in making redemptions, which is always going to dampen the amount a single pension fund can invest in property per se, and therefore the other alternatives, such as infrastructure and others, come into play.

But the characteristics of property, and particularly the income characteristics, are going to play well over the next couple of decades. The property income is not for today’s pension; it is something that is actually going to pay the pensions in 25 years’ time, and by then the income that you have generated should have kept pace with inflation.

There will be a dampener on the amount the pension funds can actually keep in property over the long term because of the liquidity issues. But there is still plenty of room for property and property income generating funds to form a reasonable part of a pension scheme’s portfolio.

Pensions Expert: What would be “a reasonable part” in percentage terms?

Vassiliades: For a smaller fund of less than £100m I am not sure there is much scope for any more than 5 per cent really, because lots of other assets have a role. For a much larger fund, where perhaps it is less mature, perhaps it still has new entrants, it has future accrual, then property could be 15 per cent or even 20 per cent of the total, but it depends on a number of factors before you get to that figure. It is not just an investment-only decision; there are a lot of liability influences and income influences that get you to where you position your property allocation.

The characteristics of property, and particularly the income characteristics, are going to play well over the next couple of decades

Danny Vassiliades, Punter Southall Investment Consulting

Vassos Vassou: I agree that many trustees like property investment because it is well understood. However, this is less true of indirect than direct property investment. Of course, indirect property investment is actually the most appropriate way to access property for the majority of pension schemes.

For me, the liquidity point will increasingly come to the fore. Many pension schemes are becoming cash flow negative, and the income property provides only goes so far in helping to pay the monthly pensions.

As a trustee, you start thinking about selling assets to pay pensions, and if your property investment is difficult to sell at a sensible price and lumpy in nature, then you will think twice before investing. That applies to investing new money and to switching invested assets into property.

Anish Butani: We have seen continued demand from our clients – be it local authority or overseas institutional investors – looking to allocate funds to the real estate market. On the fund manager side, we look at the industry and you segment risk between things such as core and core plus, which has a slightly lower level of return.

Increasingly we are seeing fund managers starting to veer up towards value-add and looking to turn around certain opportunities, and especially in the past year or so, both in infrastructure and in real estate, we are seeing more specialisation or more movement up the risk curve towards value-add opportunities.

Wellesley: I am not seeing that in my schemes. It is tempting to look at the value add, as yields have come under a bit of pressure, but if you are looking long-term, one has to be pretty confident of the value-add element before diving in – what is the additional risk you are taking, and is that something that is prudent in the context of a long-term strategy for the pension fund?