Property comprises one-third of alternative assets

Property is the biggest alternative asset class for institutional investors again, making up just over a third of the assets managed by the top 100 managers.

It is popular across investor types, forming the largest allocation for pension funds, insurance companies, sovereign wealth funds, wealth managers and banking assets. Onlyendowments and funds of funds do not have it top of the list, favouring private equity and hedge funds.

So strong is the market that parallels can be drawn with 2007. Transaction volumes are at multiyear highs, returns are in double digits and debt costs are low. Add to this the fevered atmosphere in fundraising, where money pours into funds at record-breaking speed, and you could be forgiven for wondering if you had dreamt the past eight years.

The one comforting difference, says Paul Jayasingha, senior consultant at Towers Watson, the consultancy, is that the spreads over government bonds are still much wider. In addition, much of continental Europe has yet to feel the pressure, having missed much of the rally.

He advises caution in making new property investments at the moment, but does not predict an immediate turn in the business cycle. “When there is a crisis, people question the amount of liquidity risk they want to take,” he says, but until then, appetite for real estate will increase.

“The warning signs for a correction are all going the wrong way, but they are not yet concerning,” adds Jeff Jacobson, chief executive of LaSalle Investment Management, which is 13th on the list of largest alternative managers.

Property is not a homogeneous market, says Mr Jayasingha. “There is a lot of appetite for real estate, but you have to remember it covers a broad range of asset types.”

Low-risk, bond-like assets appeal to pension funds edging towards maturity, especially given the low (in some cases non-existent) yield from traditional government bonds.

Investors looking for less security are diversifying into other segments, such as student housing, healthcare properties and storage.

“There are quite strong thematic factors driving those sectors,” says Mr Jayasingha. Healthcare property, be it hospitals or care homes, is likely to grow in response to ageing populations, while urbanisation should support the storage industry, as people get richer in possessions but poorer in space.

Student housing as an asset is driven by emerging-market wealth. Prices and yields were virtually unchanged by the introduction (and subsequent raising) of university tuition fees in the UK. “Growth in rents has been incredibly resilient and strong, as opposed to the office sector,” says Mr Jayasingha. “Emerging market students are paying to go to what are perceived as better universities in the West.”

Although it may not yet be perceived as mainstream, student housing is not necessarily moving out on the risk curve, says Simon Marrison, LaSalle IM’s European chief executive and chief investment officer. “With student housing, you have constant demand, rent paid a year up front and the parental guarantee.”

The constraints of the traditional asset allocation framework are declining as investors start to categorise their investments by the source of risk rather than the instrument involved. This factor-based investing is allowing institutions to increase their allocations to bond-like assets with predictable income streams that are more sensitive to interest rates than cyclical property prices.

“With the broader trend for liability-driven investment, people are spending less time putting it into a particular bucket,” says Mr Jacobson.

In common with asset classes like private equity and infrastructure, more and more investors are approaching the sector with alternative structures. “We have seen growing interest in co-investments, joint ventures and direct deals as investors aim to have more control and visibility on both assets and pricing,” says Mr Jayasingha.

These elements are likely to be of greater importance to investors at the high point of the cycle, when they want to keep a closer eye on what exactly they are investing in and what they are paying for it.

Since most investors are also struggling to reduce fees, the attractions of co-investment or direct investment are clear, but the challenges, including the need for substantial internal resources, mean it is not for everyone.

The one region where fundraising has not been plain sailing for managers is in Asia, in particular for core funds.

“Managers have struggled to do this, because investors like to invest in an established, stable core property fund [making it hard to raise money for a new fund],” says Mr Jayasingha.

However, in recent years a few open-ended core Asian property funds have been developed, creating a more enticing avenue for cautious investors than traditional private equity-style vehicles.

The continued growth in the asset class has not driven change among the top providers.

“Those that have been doing well continued to do well,” says Mr Jayasingha.

Source: Financial Times