Property investors set new risk, return and investment objectives
Insurance companies, pension funds and wealthy individuals are investing heavily in assets with longer term lease profiles
In the commercial real estate industry around the world, we have been seeing a wall of capital which has driven value growth in quality real estate assets in major markets in excess of rental rate growth. This has been a function of the low interest rates prevailing in many countries and the consequent strong investor appetite for real estate as an alternative asset class from a wide range of capital sources.
Moreover, the entry into the international real estate markets over the last few years of many Asian investors has boosted the amount of capital seeking a home in real estate assets. Although LaSalle's clients are primarily institutional investors, the capital flowing into real estate assets from Asia also comes from developers and ultra-high net worth individuals.
Consequently, one of the topics that is often discussed is how institutional investors have been adjusting their investment strategies and how they should be focusing their strategies for the remainder of 2015. We can identify several strategic shifts that relate to risk, return and investment objectives.
- The first shift has been of many investors focusing on real estate investments for the current income they provide. With the spread between income yields and local government bond yields at wider than average levels, the appeal is obvious. Many insurance companies and pension funds as well as ultra-high net worth investors have been investing heavily in existing assets with longer term lease profiles. Depending upon the type of investor and their risk profile, these assets are leveraged moderately at very low borrowing rates to enhance the cash yields.
- As investors scratch for additional income yield, many are looking harder at alternative asset types within commercial real estate that provide somewhat higher cash yields. These asset classes would include medical office buildings, student housing, retirement housing and self-storage facilities.
- For investors with a limited need for current income due to longer investment horizons, we are seeing a movement up the risk curve to value add and opportunistic risk profiles, including development and significant redevelopment opportunities, taking advantage of the lack of new space in many asset classes as a consequence of limited development financing having been available, particularly in Europe. Although distinct from institutional investors, many Asian developers have been acquiring sites and developing residential projects in major gateway cities where many of their home country citizens have been acquiring units as safe haven investments and as places for their children in foreign universities to live. The gateway cities of choice tend to be in countries that are transparent, benefit from strong legal systems and consequently are more stable and liquid.
- Investors with the size to invest through separate accounts where they can tailor the investment strategy, financing approach and control provisions (particularly over the exit) have grown in importance as a result of lingering frustration stemming from the global financial crisis and the lack of control many investors experienced when investing in funds together with investors with different priorities.
- Although the trend in the last few years has been for many investors to want to retain maximum control over all decisions when working through separate accounts, this is showing signs of changing. The flush capital markets make sellers and their agents biased in favour of bidders with clear and reliable decision-making. LaSalle has been involved in situations where multiple layers of approvals have worked against bidders and meant that they faced the unattractive choice of paying a premium over already full prices or of being rejected as a competitive bidder. As some of these investors struggle to get money invested in these markets they are reverting to granting discretionary separate accounts.
As always, the real estate industry is incredibly dynamic with capital markets that are increasingly global and inter-related with other capital markets. In the odd couple pairing that is often reality in real estate, the global capital flows are combined with local asset markets where the specific location, access to transportation and catchment area demographics remain critical.
For the foreseeable future, Asian investors, with a broad range of investment strategies, should continue to be in the middle of much of the global real estate investment activity.
Jon Zehner is the global head of the client capital group at LaSalle Investment Management