Our Real-estate Investment Strategy
WHAT SHOULD A PROFESSIONALLY-MANAGED PROPERTY PORTFOLIO LOOK LIKE?
We believe that a professionally-managed property portfolio should include a significant allocation to ‘non-core’ or ‘value-added’ properties. So within the real-estate portfolio, there may be both ‘core’ and ‘non-core’ components, with the latter being investment vehicles, such as value-added or opportunistic funds. These private vehicles are relatively illiquid, or totally illiquid throughout the holding period. And they may include domestic and/or international investments.
IRRs carried by property investments are typically broken into three components: i) the initial cash flow yield, ii) subsequent cash flow changes and iii) the yield change or ‘valuation’ change. The asset manager should play a significant role by:
- enhancing cash flows (repositioning of assets, hands-on asset management, striving for a better tenant mix to achieve higher rents, etc.); or
- creating value (buying assets at a secondary yield, refurbishing and repositioning them into more core assets, allowing the investor to exit at a lower property yield, and so on). Obviously, there is a correlation effect between growth in cash flows and the yield change effect.
This is why it is so important that the asset manager has an impeccable track record (to convince investors). Non-core properties should generate double-digit returns—after reasonable leverage—to compensate for illiquidity during the holding period and, of course, for the additional risk borne in relation to core properties.
By contrast, core real estate includes high-quality, ‘stabilized’, income-producing properties in gateway cities. Even though projected income from stabilized assets are subject to change, property conditions are expected to continue over the economic life of the property. Consequently, the IRR ‘required’ by investors is in single digits, given the relatively low risk incurred.
Our Real-estate Investment Strategy
Our strategy for real-estate investors remains consistent, even if market conditions are not straightforward. Investors could do one of the following.
- Buy physical properties in top-tiered property markets. This is certainly the case for first-class real estate in Europe (including the United Kingdom at a later stage), but the US and Asia should not be excluded. This strategy could be used by investors having a preference for lower-risk assets with an income investment objective, and who accept capital appreciation growth in line with expected inflation. As such, secondary (lower-tiered) markets should be avoided, but investors could move into secondary assets in top locations. As a reminder, a secondary location is near or adjacent to a prime location;
- Purchase units in a ‘real-estate private equity fund’, with an asset manager who creates value (cheaper acquisitions thanks to a strong sourcing platform, identification of ‘off-market’ transactions, converting or repositioning existing buildings to allow for yield compression, etc.). This strategy is suitable for investors with a growth investment objective, which implies a relatively long-term investment horizon with no immediate need to use the cash invested.
In some cases, the same investor may define both of these objectives for different parts of an investment portfolio.
We are convinced that investors should include listed real-estate investments in their property portfolios, even though REIT share values may reflect the characteristics and valuation of the stock market rather than that of the physical property market, at least in the short term. That said, investors receive a higher portion of REIT values in recurrent cash income (dividends) compared with other asset classes, and they offer a degree of liquidity within a property portfolio.
As mentioned, we are Positive on the value-added real-estate segment across Europe. We keep a Negative stance on UK REITs due to deteriorating conditions in the country's office markets (particularly London) and we are Negative too on a number of emerging markets in Latin America.