Property and infrastructure sit at the heart of the global economy. They are crucial to switching energy systems to the regenerative sources of power needed to halt dangerous temperature rises. They also enable greater digitalisation to keep countries competitive.
Other trends re-shaping property and infrastructure include deglobalisation and ageing populations.
To upgrade the built environment to meet our changing needs requires billions of pounds of investment. Yet alongside the opportunities this presents, there are challenges. One of the largest of which was raised by Luke Layfield of Aviva Investors (pictured).
“These are illiquid investments,” said the head of portfolio management at a business managing £45bn worth of private market assets. “You can’t turn them on and off quickly and that has been a challenge for some investors.”
This might be why defined contribution schemes have historically not carried huge exposure to private assets, despite their long-term horizons. But this, according to Layfield, is changing thanks to the introduction of the long-term asset fund regime (LTAF), which offers investors some flexibility to buy and sell illiquid assets.
“The idea that you can daily deal a real estate fund creates a mismatch between the liquidity of real estate and the liquidity of the fund structure,” Layfield said. “The LTAF regime manages these expectations better.”
Simon Redman does not agree. The managing director and head of DC and wealth at Invesco Real Estate, which manages £69bn worth of assets, said daily dealing for DC investors is possible in an open-ended real estate fund.
“The mistake people make is that they have heard a lot about UK property funds being gated, because of redemptions. But they weren’t DC funds. They were predominately retail investors, who are volatile. DC investors are increasingly stable. They are on a growth path. Little liquidity is needed in DC funds to manage business as usual,” Redman added.
This is easy to do if you are global due to the differing timing of market cycles. For example, the UK fell first in the latest cycle with the US following a year later. So diversification by geography is key. “It is wrong to think you cannot have daily dealing, daily priced global real estate funds investing in direct real estate,” Redman said.
“You do need some liquidity, but it is small,” he added, pointing to an average of 1.5% a month. Redman reminded the audience that it is higher for retail investors.
For Aware Super UK’s Katya Romashkan daily liquidity is a must to provide a drawdown to their members in the pension phase. “In addition, in Australia you can transfer your whole pension fund into another superannuation fund,” said the portfolio manager focusing on infrastructure at the Australian superannuation fund with around £9bn allocated to the asset class.
“For us it is a bit simpler, we are an overarching pension fund,” she added. “We don’t manage our liquidity within the infrastructure team. All of the hedging, daily trading and portfolio management strategy sits at the fund level.”
Redman then moved onto LTAFs, stating that they are great for publicity. “They are not, however, platform compatible because they do not daily price or daily trade.
“A huge amount of the industry is on platforms and we need to provide for that. The LTAFs don’t, with one or two exceptions,” he added.
Layfield was quick to respond that Aviva Investors’ LTAFs are daily priced and available on platforms, they are just not daily dealt.
Sustainable thinking
The conversation then turned towards the environmental, social and governance (ESG) aspects of investing in the built environment.
This is a big issue given that infrastructure and property are collectively responsible for up to 40% of all climate-harming greenhouse gas emissions.
“Infrastructure is there, it’s big and it’s needed,” Romashkan said. “We cannot yet teleport so we will continue to need transport that is polluting.”
So how can investors make a financial return while being kinder to the environment, given that construction, renovation and operational assets all emit carbon into the atmosphere?
“The benefit of private markets is different asset classes can play a different role in delivering net zero,” Layfield said.
Infrastructure focuses on avoiding emissions through, for example, renewable sources of energy and electric vehicle charging points.
Real estate, meanwhile, focuses on reducing emissions, which typically means turning brown buildings green. For Layfield, this is a big challenge given that three-quarters of the buildings standing in 2050 have already been built. “Doing this [upgrade] in the right way could generate a premium as well as having a transition impact.”
As an example, he pointed to a 50,000-square foot Victorian warehouse in Shoreditch, which Aviva Investors is transforming to meet demand for energy-efficient properties.
According to Layfield, retrofitting the property with solar panels on the roof, better insultation, upgrading the windows and installing electric heating systems will more than double its rent to £90 a square foot.
“This is a real life example of how we are making a financial return from investing in alignment with the transition,” Layfield said.
Redman was quick to extinguish any misunderstand investors may have on this point. “It is wrong that some people think you have to compromise on financial return to be sustainable.
“If you make a building more energy efficient the occupational costs – waste, electricity, water – go down, which may allow you to increase the rent slightly,” he added.
Sustainable buildings are also more liquid given that there is a larger pool of tenants with a rising number of corporates wanting to occupy buildings which are sustainable. Undersupply of these assets may also mean that rents are higher.
Yet it is difficult to make the re-development of buildings greener, given the that “construction is inherently un-environmental, as concreate has a lot of embedded carbon”, Redman said.
However, to reduce this impact Invesco recycles concrete onsite in its re-developments and prefers not to construct new office buildings.
One of the issues here is that it’s currently impossible to have a carbon-free building. There will always be some residual emissions.
However, Aviva Investors has a private markets strategy to solve this issue. The asset manager has bought 6,000 acres of moorland in Scotland where it intends to restore peatland and implement a woodland creation scheme to generate carbon credits to offset the residual emissions in the portfolio.
“It is not just about directing capital towards green infrastructure but also creating carbon sinks to cover the emissions they cannot remove,” Layfield said.
Yet ESG in real estate is not just about making positive environmental impacts. “Investing in residential can have some important social gains,” Redman said. “We can improve the social side of things through constructing the right buildings in the right way in the right location.”
This means providing more social housing in residential developments without segregating amenities. Another benefit would be to create compelling working environments, which include gyms and wellness areas.
Trouble in America
Across the Atlantic, there are regulatory tailwinds, which could weaken the investment case for the climate transition. “This means we have to take a longer-term view with some of our investments,” Layfield said. For example, Aviva Investors has invested in EV charging points but is seeing a lower-than-expected adoption of electric vehicles.
“The direction of travel is the same, but it just might be a bit more volatile. There is still broad policy support and the longer-term trend remains the same.”
Redman brought the discussion to a close by reaffirming that political issues in the US are not having a material impact.
“Irrespective of what is happening with regulation, we are not being forced to invest in this way. It adds to the financial performance, so why wouldn’t we continue.”
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