Schemes are looking towards property for further diversification, having expanded alternative property investments fivefold last year, as experts predict improved economic sentiment and a lack of development sites could stimulate rental growth.
The Financial Times reported this week that strong activity in commercial real estate is expected for 2014 – especially in London, where the first quarter of the year saw £4.3bn invested, of which two-thirds of transactions came from UK-based investors.
Data from property index provider IPD showed pension funds hugely increased property investment last year, including putting more than £400m into alternative areas of commercial property, showing strong interest in index-linked leases backed by strong covenants (see table below). This is up from around £74m the previous year, and just £9m in 2011.
“It is currently an attractive time to invest in UK property,” said Andrew Jacobson, a consultant at LCP responsible for property research. He added some schemes are considering property to diversify away from equity allocations, as the economy pick-up and a lack of real estate development space means “good news” for investors.
But he said pension schemes should be looking at “best secondary” properties – good-quality properties that are less expensive than the prime assets found in central London and parts of the southeast.
Net direct investments by UK pension funds: Dec 2009-13
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Source: IPD
Peter Martin, head of manager research at consultancy JLT, said he expected long-term total returns from the asset class to be around 6 per cent a year, but warned schemes to be wary of a “grab for yield”.
“Some tertiary or secondary property will have high yields for a reason,” he said. “Requirements for retail and shopping centres are evolving, and investors need to be very careful.”
Martin added that the disintermediation of the banks within the asset class has also provided schemes with opportunities in areas such as senior loans and mezzanine real estate debt.
Manager and cyclical risks
Jacobson said schemes should pay close attention to “redemption pressures” – either as a result of poor fund performance or market crises – and should fully understand the terms of any pooled fund in which they invest.
He said some of this risk can be mitigated by using multiple managers. “This can be done either by allocating to two or more managers, or for larger pension schemes by using a multi-manager approach,” he added.
Don Jordison, managing director at Threadneedle Property Investments, said the illiquid nature of the cyclical asset class can exacerbate the effect of flows in and out of the sector and can lead to periods of “irrational bidding” to obtain exposure.
“These periods are to be avoided and trustees should carefully assess the record of managers when dealing with excess flows in and out of property,” he said.
Emma Grew, senior research analyst at M&G Real Estate, said while property’s rental fundamentals are picking up and greater investor appetite is driving capital growth, she warned any “hiccoughs” could stifle the emerging property market recovery.
She said the impact could be felt either by “the improvement in occupier demand or by potentially reversing the recent reduction in risk aversion that has been driving the property market in recent months”.
