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REAL ESTATE: members only

Real estate is slowly resurfacing as an investment target, but certain clients will be far more specific about how they invest, finds Nick Fitzpatrick

leather.jpgCommercial property is starting its long-awaited comeback as an asset of interest to retail and institutional investors. The ATP Pension Fund, the largest pension scheme in Denmark, recently invested US$100m (€72.74) in a LaSalle property fund directed at a menu of US real estate including retail, office and residential.
Further, property was the third top-selling sector in Q4 2009 in the UK retail funds market, according to Lipper FMI figures. Overall the retail sector achieved record levels of £3.2bn (€3.5bn) in the quarter.

But as property investment starts to shine again, investment managers can expect some of their institutional clients to take a greater lead in dictating the terms and conditions of business.

The financial crisis revealed that leverage in some real estate funds was too high for certain investors. The crisis showed also that it could be overly risky to invest in funds alongside investors whose ambitions are not aligned or who may not be able to meet their funding commitments.

With these concerns in mind, ATP Real Estate, which runs the €3.5bn direct and indirect property portfolio for the ATP scheme, plans to increase the amount of ‘club’ investments it makes.

Meanwhile, DTZ Investment Management’s multi-manager division, which has £380m (€417m) under management, says it will advise more of its larger clients to follow the club approach where possible too.
Club investing means institutions know exactly who they are investing with and can negotiate the terms of business, such as the amount of leverage a real estate manager can use, with their fund manager.

Club investment in real estate is not new. ATP, whose property portfolio has 30 funds in total covering Europe and the US, already belongs to six clubs. But Michael Nielsen, CEO of ATP Real Estate, says its property exposure will include more clubs in future.

“We will not only invest in clubs, but we will do so when it is right,” he says. ATP club-invests in Finland and Sweden, the latter where it uses Areim, a Swedish fund manager.

“Clubs give us more influence on the investment strategy, on the terms, and on the governance. They also mean we are able to choose who we invest with.”

Having the power to select other investors is important, Nielsen says, because this helps align exit strategies, investment horizons, and gives greater confidence in the levels of capital injection available.

“Investors have to be aligned and likeminded, yet we have seen the opposite in more standard real estate funds where there may be 20 to 30 investors. When someone wants to get out, for example, it can be complicated.”

Clubs also give investors the ability to identify the right investment managers for strategies and geographies. Managers may also be expected to invest their own money, though the size of commitment would generally be proportionate to the manager’s size. Sums from club members may be larger – Nielsen indicated €75m each as a benchmark – but each investor’s contribution will be roughly the same to prevent “big brothers” in the fund.

Wendy Arntsen, head of multi-manager at DTZ Investment Management, says: “Standard funds are very much prepackaged and stamped with key ingredients that determine, for example, that maximum leverage will be as high as 70%-80%. These high levels of leverage amplify exponentially the volatility of returns.”

Nielsen agrees: “We had some instances where managers came to us with 60-80%-geared funds and we rejected them because of the strategy and risk profile. We’ve rejected many funds because of their too aggressive use of leverage.”
Post-crisis, institutions will want low gearing, Nielsen says, while Arntsen adds: “Even though today is probably a better vintage to apply leverage than a couple of years ago, I think investors will have a different perspective about long-term leverage. The consequences in terms of investment returns in a downturn can be severe and can create the additional risk of needing to inject more capital to prop up balance sheets.”

Oliver s’Jacob, real estate funds specialist and partner at law firm Reed Smith, says: “It’s clear that, during the boom, some property fund managers lost sight of two fundamental truths: one being that prices can go down as well as up and the second that gearing works both ways.

“Ironically, managers that were complaining five years ago about the restrictive leverage limits then imposed by regulators in some jurisdictions like Luxembourg are now thanking their lucky stars that they were prevented from borrowing the amounts they’d wanted to at the time.”

S’Jacob sees club investing developing in the medium term. “At this stage in the cycle, we’re not sure investors see a real need to join together, as even smaller investors are getting what they ask for.

“However, coupled with the additional regulatory burden to be imposed by the EU’s AIFM Directive when it finally comes into force, these factors may well lead to a gradual power shift towards the larger fund managers who alone can utilise economies of scale to maintain decent investor returns in spite of the double whammy of reduced fees and increased costs. 

“As competition for capital decreases, smaller investors could then see their bargaining power decline unless they can club together and get their voices heard.” 

But the problems for fund investment do not stop at leverage and the quality of co-investors. Arntsen says complicated and opaque debt structures used by real estate funds increased the difficulties.

“Investors may not know what the life of the debt is and how long it has to run. If the debt is not long enough to match the asset management programme there might be a need to refinance and the availability or terms for any new debt are not known at the time of investment.”

Simon Redman, head of business development at Invesco Real Estate, says Invesco provides investment management to five club clients, each with five to ten investors, across a variety of investment themes.

“The very largest investors will do more club deals for the control and visibility it gives them. Club investments probably account for a disproportionate amount of capital in market, but by number of investors they are not that many.”

Larger investors may also look at joint ventures with real estate managers, says Arntsen. JVs typically have two parties – the investors and the manager.

“There has always been a preference for large investors to do JVs if possible,” she says.

ATP is no stranger to this model either. Together with ABP, the large Dutch pension scheme, it formed a £500m (€552.4m) joint venture with Hemingway Properties called Greenhills Real Estate in 2006 to acquire and operate various properties in the UK.

What can institutions do if they want to form alliances, such as clubs? Nielsen says ATP started some of its own clubs and was invited to join others.

“Networking is the usual way. Inrev [a European association for non-listed real estate investors – see p64] is a good start,” he says.

Managers can benefit from clubs too, with consolidated custody, for example, which could be particularly helpful for international portfolios.

Yet real estate fund managers are reacting to the worries of investors in other ways. A sign of this is Aviva Investors’ UK Real Estate Recovery Fund, launched without gearing and targeting 8-10% returns. This stands in contrast to one of Aviva’s other funds – The Mall Fund launched in 2002 – which is 78.4% geared.

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