December-January 2017

LEGAL EASE: Real estate the way investors want it

Eight years after the financial crisis, income-rich real estate is exerting a powerful pull on institutional investors hunting for yield in a low interest rate environment. The effects of this pull towards an already popular and maturing asset class have been profound, as institutional money has flocked to developed markets from around the world. The volume of incoming capital asks new questions of fund managers, and their responses are changing the shape of the real estate funds industry.

Investors want greater exposure to real estate. This means as well as facing greater competition for assets, fund managers need to deliver opportunities for larger investors to co-invest alongside funds, in joint ventures and through segregated mandates. It also means institutions are looking at assets outside traditional sectors and established markets, which means more funds looking at regional geographies and investing in ‘alternatives’ (which means anything outside office, retail and industrial, like student accommodation, healthcare and logistics).

MAKE IT MORE LIQUID
If rental income acts as a substitute for bond yield, can it also provide liquidity? Not really, because property is illiquid and much more commonly held in unlisted vehicles. This has not prevented the industry from attempting to solve the ‘liquidity mismatch’. More managers are offering open-ended structures, there is growing interest in listed Reits, and a regulated market for property securities may launch in early 2017 if the FCA gives its blessing. Even so, well-publicised, post-referendum suspensions of UK retail property funds reminded us that there is a limit to the liquidity that real estate can offer. It’s better at long-term liability matching.

Many investors need to reduce their expenses, particularly pension funds managing shifting demographics. This means larger sums are increasingly placed with fewer managers, giving investors a stronger platform for negotiating lower fees. The need for many institutions to reduce costs also drives them to seek closer relationships with the managers that they do choose, with the aim of generating a more exclusive asset pipeline and helping to build further in-house property investment expertise.

Uncertain times only boost investors’ interest in building globally diversified portfolios. So more fund managers are offering pan-European property funds, and it is easier than ever to gain relatively cost-efficient access to international real estate markets via global multi-managers and funds of funds. This kind of diversification often complements a portfolio of domestic direct investments built up initially under an investor’s home bias.

MORE REAL ASSETS PLEASE
And investors are still seeking ever more income-generating, long-hold, inflation-hedging, diversifying investments. This thirst is encouraging investors to combine infrastructure and real estate under one ‘real assets’ banner. Fund managers are now spanning both the real estate and infrastructure sectors, which share a focus on physical assets, long-term investment horizons and solid income returns. The same asset type, such as student accommodation or healthcare, might now attract both real estate and infrastructure funds.

Over the past 15 years, real estate has gone from being the ‘new fund on the block’ to a fully fledged and diverse alternative asset class, one that is competitive, dynamic and very real.

Amanda Howard is partner and Tom Taylor is knowledge lawyer at Nabarro

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