The search for yield has revived a once extinct asset class for cash-hungry pension funds. Mark Dunne looks at whether residential property really is as safe as houses.
“In London we have seen office rents halve and then double again. It is a volatile market, but if you look at rents for flats, they creep up with inflation.”
Richard Tomlinson, Local Pensions Partnership
Institutions have found a new home for their cash. The UK’s housing shortage has created an opportunity for pension funds to generate long-term income through building and renting modern apartments.
The Lancashire Pension Fund and the Northern Ireland Local Government Pension Scheme are just two retirement funds that have become residential landlords by entering the private rented sector (PRS).
Traditionally the domain of property developers, the market, also known as build-to rent, is an alternative investment that pension funds are turning to in their search for long-term, higher-yielding assets.
The question is should other pension fund trustees grappling with the low yields offered by high-grade debt and widening deficits follow their lead in gaining exposure to residential bricks and mortar? It could satisfy the regulator, who has been pushing government schemes to diversify their portfolios towards real assets such as infrastructure.
The market is attractive when looking at its track record. PRS assets in the UK returned on average 13.4% annually between 1971 and 2009, according to the IPD. This beat the 12.6% gain recorded by equities and the 10.1% collected by those owning gilts during the same period.
Its returns were also superior to those produced in other areas of the property market. Between 2000 and 2013 residential logged a 10.5% total return, compared to 7% by retail, 6.6% by offices and 6.9% for those investing in warehouses and factories. The IPD All Property Index gained 6.9% during that 13-year period.
Residential’s performance is driven by its fundamentals, not market sentiment.
Demand for housing in the UK outstripping supply is core to the investment case and with an additional 10 million people forecast to be living in the country by 2039 the need for new housing will remain buoyant. Indeed, Investec predicts that there will be a 1.1 million housing deficit in 2020, up from a 600,000 shortfall in 2014.
This is a factor in real estate consultancy Knight Frank’s forecast that institutional investment in build-to-rent will almost treble to £70bn by 2022, up from £25bn today.
That £25bn only accounts for 2% of the UK’s PRS market, so with a growing need for investment expected there is an opportunity for more and more renters to have an institution for a landlord.
“There is real potential for institutional PRS to take a bigger market share and a bigger share of what is a growing market,” says LaSalle Investment Management’s head of real returns strategy, Chris Fry, who has invested £390m in this space in the past two years.
Other attractions for pension funds to build new homes include residential’s low correlation to equities, gilts and commercial property.
It is also not as vulnerable to political and economic shocks, with M&G Real Estate residential fund manager Alex Greaves pointing out that in the past two downturns housing proved more robust during “dips in the cycle”.
THE HOUSE THAT LANCASHIRE BUILT
M&G made its first investment in this market back in 2013 and today boasts of a £600m residential fund that owns around 1,700 flats across 22 buildings and has 25 investors. These are mainly local authority pension schemes, including the Northern Ireland Local Government Pension Scheme, which has committed £100m to the strategy.
Another asset manager with a PRS strategy is Invesco Real Estate, which has allocated £450m to putting a roof over peoples’ heads. This has given the fund a portfolio of around 700 apartments with another 1,300 under construction.
One of these projects is the Gatefold, a 119-apartment building in Hayes, West London, which was part funded by the Lancashire Pension Scheme. The first brick was laid on the project in 2014 and was the retirement scheme’s first foray into the residential market.
Selling the project to the scheme was not too difficult. Local Pensions Partnership (LPP), the investment decision-maker for the Lancashire Pension Fund, wants long term cash returns that track inflation. This makes residential a more attractive investment than shops, factories or offices.
“In London we have seen office rents halve and then double again,” LPP investment director Richard Tomlinson says. “It is a volatile market, but if you look at rents for flats, they creep up with inflation.” So when Invesco approached him with the idea for a project on the scale of Gatefold, it ticked a lot of boxes on Lancashire Pension Fund’s investment checklist.
