IPE Real Estate spoke to six major European real estate investors about their current holdings and strategies for the future

The questions we asked:
What is your current allocation to real estate within your portfolio? Are you at your strategic asset allocation levels? What is your short-term strategy for real estate (next year) and longer term (over next three to five years)?

What are the reasons behind your current allocation and strategy? (Why increasing, decreasing or remaining static–ie, attitude to real estate.)

If changing your allocation, either short-term or long-term, how are you going about this in terms of timing, type of investment (direct/indirect), area of investment, particularly if going more international?

Are you investing primarily for income or returns? What impact does real estate have on risk in your portfolio?

In your view, what developments would make investing in real estate more attractive to investors? (Eg, property derivatives, better secondary fund markets, more liquidity, etc.)

What are your main concerns and worries about allocating more real estate investment? (Eg, market conditions generally, short-term bubbles.)

Andre Ludin, Novartis Pensionskasse
Basel-based Novartis Pensionskasse has between 10% and 12% of total assets invested in the real estate sector. There are no plans to change this asset allocation level in the short- or long-term, says André Ludin, head of portfolio management at the Novartis fund.
“Ten years ago, the allocation was higher, at between 15 and 20%,” he says. “But since then the share market has moved very rapidly, and so the importance of real estate has receded.”
Ludin says there is no short-term strategy as such for real estate. “It all depends on other things in the market. If nothing happens in bonds, and the share market remains dead as it is now, then perhaps we would consider making some changes.”
The property allocation is all held in a Swiss real estate fund, he says. None of the money is used to invest in overseas property. Ludin sees value in keeping these investments within the domestic sphere, primarily because the market is a known one. “I have a feeling about the market here,” he says. Switzerland is a small country, and one hears first-hand information about the property market and the state of rental demand, for example. The investment is more stable than it would be were the fund to take on international property, he says.
In many ways, real estate does not really suit a retirement pension fund in terms of liability matching, says Ludin. “We are an old-age pension fund and in view of that, real estate is a bad investment because you need liquid assets. But for cashflow it is a good one because it generates an income.”
Real estate provides good diversification within the fund, he says. “It is good to have not all of the fund in shares and bonds,” he says. But the low level of liquidity associated with the asset class is a risk of sorts. “The only risk is that we cannot move from one day to the next,” he says.
Ludin says that the availability of property derivatives could increase the appeal of real estate to other investors. “Maybe one could use derivatives to make a hedge. But the question is, who would be the counterparty?” If derivatives are so useful with stock market investments, then why not for real estate?
When investors are using property funds to get a foothold in the investment sector, it is important that they have a thorough understanding of how that fund is invested, says Ludin. Most people, he says, are not interested in looking deeply into the fund. “When you ask people where their real estate fund is invested, they have no idea.”
But this is an important point, he says. It is vital to know the quality of the fund you are in, and to look beyond the headline yield that the fund can produce.
International investment can have its dangers, says Ludin. Although he is not worried about bubbles in the property market within Switzerland itself, he can see pockets elsewhere where prices may not be stable. “Maybe in some countries, there are bubbles. When you look at real estate in North America, where a lot of the houses are built from wood and buyers are paying high surpluses in that area… I would say it is not a stable market,” he says. The market is simply at its current high levels because of a wave of demand.

Daniel Gloor, CSIF
In Zurich, the Civil Service Insurance Fund Canton of Zurich (CSIF) has 17.5% of its assets in real estate. The fund’s total asset base stands at around Sfr17.2bn (e11.2bn). So far, says Daniel Gloor, the head of asset management, the fund’s property investments have only been made within Switzerland.
Property assets held by the fund are split up into Sfr2.887bn in direct Swiss real estate investments and two investments of Sfr126.1m in real estate shares listed on the Swiss Exchange, says Gloor. The current strategic quota is 18.9% – slightly above the current investment level, and the long-term strategic quota is around 20% (18–25%) of total assets, he says.
Disappointing equity performance and a poor outlook are at the root of the fund’s moves to boost its property exposure.
“Due to the bad performance of equities markets in 2001 and 2002, the dim outlook for equities markets for the next five years and the current limited risk ability of the pension fund, CSIF reduced its strategic equity quota in 2003 from 33% to 25%,“ says Gloor.
But the strategic quota of tangible assets - equities and real estate – is supposed to be 40-45% at least. Otherwise, he says, it could be difficult, given current low interest rates, to achieve a yearly minimum target performance of 4.5% on total assets.
“Therefore, CSIF decided to increase investments into real estate,“ he says. The next step will be for CSIF to make real estate investments abroad as well, to diversify. The budget for 2004 allows for Sfr200m for Swiss real estate and Sfr100m for foreign real estate respectively, he says.
Gloor says CSIF will soon set up an investment foundation for foreign real estate investments. “The foundation will be set up by different Swiss pension funds and will make investments in different regions - at the beginning primarily in Europe – using different investment vehicles, direct investments, listed shares etc, evaluated by local professionals.“ In the first year, CSIF will provide Sfr100m, if there are suitable investments. The foundation itself, he says, should start with around Sfr150m in 2004.
The investment goal for real estate is primarily to get a return in line with market conditions, says Gloor. Risk implications for the whole portfolio are much lighter than they are for equities. “The Swiss real estate portfolio proved to be a very stable investment category in good and bad times and shows a very favourable risk/return pattern in the long run compared with equities,“ he says.
Looking at ways that the property markets could be made more attractive, Gloor says derivatives would make little difference to a fund like CSIF. “Since CSIF is only investing into attractive real estate investments with a long-term investment goal, we are not looking into derivatives,” he says. “However, liquidity or secondary fund markets are always of some importance to us with regard to the investment process, especially if investing on a big scale.”
When it comes to considering future investments abroad, Gloor says the fund has to be aware that many countries and regions - the US, UK and Spain, etc - have shown strong price increases in property over the last four years. “As is the case for any investment, past price increases, economic stability and local expertise of the different real estate markets are of great importance,” he says.
“So it will also be quite demanding to establish a successful long-term investment strategy abroad, depending on the regions and on the kind of real estate the foundation is going to acquire,” he says. In the long term, the investment return on foreign real estates is expected to be around 5% in Swiss franc terms.

Ton Zimmerman, Nedlloyd
The Nedlloyd corporate pension fund, in the Netherlands, is in the process of increasing its allocation to property. At the end of 2003, real estate investments accounted for 15.6% of assets - E194.12m out of a total asset base of E1.249bn. “The strategic real estate asset allocation for the longer term is 20% of investments,” says managing director Ton Zimmerman. This is divided into residential (3.5%), retail (7.5%), offices (7%) and others (2%).
“For this year we aim at an allocation of 18% and we hope to reach the 20% level in 2005,” he says. The allocation is a mixture of directly owned real estate - the actual bricks and mortar - and investments in indirect real estate - unquoted property funds. The fund has opted for unquoted funds, says Zimmerman, to have an asset class which really behaves like property, “because we only want the real estate characteristics, and not the equity ones in this part of our portfolio”.
Based on the asset/liability study which the fund conducted last year in cooperation with consultancy Ortec, a decision was taken to increase the allocation to real estate from 13% to 20% of investments. “This was done to improve our indexation policy without deteriorating the risk/return profile of the fund,” says Zimmerman. In the ALM model a 6.25% real estate return was used, although the Nedlloyd Pension Fund has made an annual return of 10.5% over the past 10 years.
Rather than get involved in the risky game of picking precisely the right moment, the fund has opted to take the slow, steady approach to taking on new property investments. “We do not pretend to know something about market timing, so we are making our investments and changes there gradually over time,” he says.
Although the overall weight of property in the portfolio is increasing significantly, the allocation to the different kinds of sectors of real estate remains unchanged. “If we are not able to acquire direct real estate at our terms, then we try to invest in indirect real estate,” says Zimmerman. For direct real estate, the fund limits itself geographically to the Dutch market.
“We have this general rule not to invest ourselves outside the Dutch market,” he says. “If we want to do that, we have to outsource that or invest in funds. For diversification purposes we have made a first step on the international real estate market through an investment in a property fund.”
For the Nedlloyd pension fund, both income and return are equally important, although there is a slight preference for income as it is, now, a very mature pension fund. The real estate held by the fund helps it lower its risk profile. The strategic allocation of the fund, apart from the 20% in real estate, is 50% in fixed income, 27.5% in equities and 2.5% in alternatives.
Zimmerman says that liquidity would make investing in real estate more attractive than it is at the moment.
Is Nedlloyd worried about the outlook for property investments? “We do not have many concerns about allocating more to real estate investments although we would like the economic situation to improve especially its impact on the office sector,” says Zimmerman.

Olivier Poswick, Tractebel
Belgian pension fund Tractebel holds just under 10% of its entire portfolio in real estate assets. The fund’s strategic asset allocation levels were reviewed last year, and in June 2003, the investment committee approved a move to raise the property allocation to 10% from 5%.
Now that that decision has been taken, there are no plans to change it in the short or longer term, says Olivier Poswick, senior equity manager at Tractebel. The changes made at the last review were made for the next three to five years, he says.
The fund’s previous allocation was 55% equities, 37.5% bonds, 5% real estate and 2.5% alternative investments. “With the new strategic allocation, the objective is to have a portfolio which is able to deliver a good risk/return balance, but is also able to absorb short- and medium-term market shocks,” says Poswick.
“So we split the portfolio into three different zones,” he says. There is a stability zone, which consists of investment-grade bonds, a buffer zone made up of real estate, convertible bonds and hedge funds and a returns zone made up of equities and corporate bonds. So property is part of the buffer zone whose role is to limit and reduce market and economic shocks and have a good correlation with traditional asset classes, says Poswick. So the real estate allocation was stepped up to have broader diversification than before.
“We are quite confident with property over the long-term,” says Poswick. The current allocation is around 9%. “So we are a little bit cautious regarding current real estate valuations.”
Of the property allocation, 85% is held in quoted real estate investments and the rest in private vehicles. “So we are not fully invested in unquoted real estate,” says Poswick. “We have already selected the manager for the private portion, and we will invest by the end of this year.”
In terms of quoted real estate, Tractebel does not have global exposure and has no intention of going in this direction. Investments are confined to France, Belgium and the Netherlands. “Because these areas show lower volatility and higher yields,” he says. The UK and Spain are interesting property markets, he says, but more speculative.
Tractebel’s real estate investments are primarily held for the sake of income rather than returns, Poswick says. Within the entire portfolio, real estate reduces risk because of the correlation between property and equities, he says, which is 0.5%. Volatility as standard deviation is 19% for equities, while it is 10% for property. This compares with an expected return of 7.5% for equities and 5.5% for property. Given a normal return for traditional bonds is 4.5%, this gives property a risk premium of 1% against 3% for equities, he says.
“It depends on the role you give to real estate in your portfolio,” he says. “I consider it could be interesting for us to invest in private real estate compared to quoted, because the correlation is lower (compared to equities). But it is difficult to select a very good manager for private real estate,” he says. Like private equity, when using a private real estate manager, you are required to commit investment to a fund without having any idea about the actual underlying investments.
Tractebel has no plans to raise the proportion of its funds it currently has earmarked for property. But if in the future it did, says Poswick, it would be important for the management to have a very good knowledge of the different segments of the real estate market. A deeper analysis would be necessary.
“The best-of-class buildings, for example. Private real estate is very expensive, but perhaps it would be possible to find these opportunities,” he says, if one had sufficient knowledge.

Steen Jørgensen, Finanssektorens Pensionskasse
At Finanssektorens Pensionskasse, the Copenhagen-based pension fund for financial sector employees, property is taking on a heftier role. The fund has lifted its strategic asset allocation to real estate to 10% of total assets. Right now, 7-7.5% is held in property.
“But it takes a while to invest in real estate,” says Steen Jørgensen, managing director of the fund. He estimates it will take the next two to three years before the fund is fully invested in property.
It is unlikely that the Danish fund will increase its allocation to property again in the short or medium term. “I don’t foresee that for the time being, because real estate is less liquid than other asset classes,” says Jørgensen. And the fund has already stepped up its exposure to less liquid investments. “We have increased our investment in other less liquid asset classes, for example, private equity,” he says. There is an overall limit to the level of illiquid assets it is sensible for the fund to hold.
The main reason behind the decision to become more heavily involved in property, is that it is a more stable asset class in terms of return, says Jørgensen.
The fund is increasing its investment levels in existing areas of exposures. “In the UK, we have a company set up for that purpose, and in Denmark, we have two to three new investments,” he says. “That’s why it takes a while, with due diligence and having to negotiate terms.”
Holdings are split between residential and office buildings in the UK and Denmark - the fund’s primary focus at the moment geographically. “We have diversified in the whole Nordic region,” says Jørgensen.
Knowing your marketplace well is an advantage in real estate investment, he says. “As long as we are not that invested in Europe, we are not looking outside it. There are still lots of opportunities for risk diversification here,” he says.
The property holdings are mostly aimed at producing returns rather than income for Finanssektorens Pensionskasse. “It’s a good risk diversifier and a very stable asset class.” Property is a notoriously illiquid asset class, and this is part of the reason why the fund is happiest investing in the UK and Denmark. “These are markets we know well. We know more people there, so it is easier to sell a property because we have the contacts. And the UK market is the most liquid in Europe.”
Some of the investments held are direct, and others are held via investment vehicles, though this doesn’t include any funds, says Jørgensen.
In terms of how the real estate market could become more attractive to a broader spread of investors, Jørgensen believes an improved secondary market would help. “If there were a better secondary market for property, then that would probably facilitate more investment,” he says.
Jørgensen does not see any major problems ahead for the real estate market, but the tightening of monetary policy is bound to cause some trouble. “There is a risk of interest rates going up again, and some people argue that the market is a little overheated. We don’t think so, but if interest rates do go up, then that would put downward pressure on returns,” he says.
Is there a short-term property bubble? “We don’t think so. And we don’t foresee interest rates going up significantly in Europe for the next six to 12 months,” he says.

Tom Mergaerts, Amonis
Belgian sector pension scheme Amonis (former VKG) is holding its real estate allocation steady at around 10%, although the current investment level stands slightly higher at 10.11%.
“It has been at this level now for the last year and a half,” says finance director Tom Mergaerts. “The only change we have made is that we moved to equitised real estate instead of fixed real estate,” he says. The fund undertook this move at the end of 2001, he says.
The reason for the shift was to enable greater geographical diversification. “Before we were only invested in Belgium, and we wanted to move out to different areas, to the US, the UK and the rest of Europe,” says Mergaerts.
“The equitised real estate that Amonis now holds is in the form of shares of property companies rather than actual bricks and mortar,” he adds. “It’s equitised and that’s the important thing.”
Amonis has no plans, either in the short term or further out, to up its strategic allocation to real estate from the current 10% slice.
The main reason for holding real estate is diversification, says Mergaerts. “If you take asset allocation - equities, bonds and real estate - we believe that the 10% holding provides good diversification. There is correlation with normal equity and bond markets. That is mainly the reason. We have a little lag of performance with the real estate - it is like equities, but comes later in the cycle.”
Within the investment vehicles it uses, Mergaerts says Amonis is exposed to all different types of property, including shopping malls, office space and residential.
When the fund made the move towards equitised real estate with a much broader geographical horizon, switching money out of the investment it had with mainly one company, it did so steadily over a period of time. “We sold the shares of that company gradually,” says Mergaerts. The way it now holds its property investments gives the fund the advantage of greater liquidity and versatility, he says.
Amonis’ real estate holding is in the hands of an active asset manager, the Brussels-based Houlihan Rovers. It is the manager that makes the decisions on optimal geographic spread, says Mergaerts. “We have a real estate asset manager who has sufficient freedom to decide how and where to invest, within some prestated boundaries. There is for example a downside limit towards investing in European real estate of 75% of the real estate portfolio.”
The fund invests chiefly for returns. Real estate investments reduce risk within the portfolio, he says, because they have low correlation. “It behaves like equities but with a different timing,” says Mergaerts. The effect is one of time diversification.
If there were anything that could make property more attractive to investors, it would be greater liquidity, he says. “Liquidity is probably the main problem.” But technical factors such as this are not behind Amonis’ decision to keep its property stake steady, nor is it concerned about the outlook for the market. “It is because we think 10% allocation is already a big piece,” he says. “There is the issue of returns… Does it generate enough in terms of returns?”

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