Volatile yields in the eurozone sovereign debt market are helping to steer some regional institutional investors further into core private equity real estate strategies.
In seeking a more consistent income stream to help match pension liabilities, investors are turning to real assets in core property to provide “yield, capital preservation and obviously security” in the long term, said J. Allen Smith, CEO of Pramerica Real Estate Investors. Based in Parsippany, N.J., the firm manages about $45 billion in real estate strategies.
One of the most recent to expand its exposure to private equity real estate is the 500 billion kroner ($96 billion) ATP, Hilleroed, Denmark. Earlier this year, ATP announced it would allocate about $1 billion to the ATP REP II investment program, a real estate fund of funds managed by ATP Real Estate. ATP is aiming for a diversified strategy, with a “substantial allocation to core investments through funds, joint ventures and club-type investment structures” in Europe and the U.S., said Ville Raitio, investment manager at ATP Real Estate, the internal real estate investment arm of the pension fund, based in Copenhagen.
So far, about 22% of ATP REP II's target allocation has been committed, including: $80 million in the Morgan Stanley Prime Property Fund investing in U.S. assets; e50 million ($72 million) to the ECE European Prime Shopping Centre Fund; and 300 million kroner to Norden IV, which focuses on Danish real estate. Overall, about 5% of ATP's total investment portfolio is invested in real property assets.
“While we are looking for return from capital growth, there's a heavier focus toward income through core investing,” Mr. Raitio said. “When it comes to our real estate investment philosophy, one of the primary purposes is to provide an inflation hedge — this is the starting point of the way we view real estate.”
Data specific to European investors were not available, but sources said they are key contributors to worldwide private equity real estate fundraising. Globally, 18 private equity real estate funds raised a total of $11.2 billion, a 25% increase for the quarter ended June 30 from the previous quarter, according to Preqin, London-based provider of alternative investments data. In the quarter ended June 30, 2010, $7.3 billion was raised.
European institutions are adding exposure to private real estate equity funds that invest in prime assets in gateway cities such as New York and London. They're also targeting “very well-defined strategies” such as senior housing in the U.S. and office rehabilitation projects to meet new carbon reduction standards in France, Mr. Smith said.
Earlier this year, PREI — also known as Prudential Real Estate Investors in the U.S. — attracted about £100 million ($165 million) in new investments to its U.K. ground lease strategy from institutional investors such as pension funds. Typical yields are about 4% to 4.5%, attracting investors looking for an alternative to fixed-income strategies within their liability-driven investing portfolios because of consistent cash flows that are backed by the underlying collateral of the assets. The fund targets leases of at least 75 years, therefore providing “long-duration income” for investors, Mr. Smith added.
Relative to eurozone fixed income, “it's tough to see how (investors) would lose money if they've done their homework and are investing in prime assets in premier gateway cities, using low leverage, and holding for a long time period” Mr. Smith said. While he declined to name new clients in Europe, Mr. Smith said about $9 billion of PREI's total assets under management are sourced from Europe, the Middle East and Africa.
However institutional investors in Europe, as with other regions globally, face a lack of market momentum caused by negative economic indicators such as high unemployment, higher-than-average vacancy and anemic growth. “If you can withstand the volatility over a long period of time, then you might be looking at (returns of) 6% or 7% for such a low leverage core strategy,” Mr. Smith said.
Others such as Claude Angeloz, partner and co-head of the private real estate team at Partners Group AG, cautioned that with the number of institutions piling into core real estate investments, the market is becoming expensive. Pricing for core assets in gateway markets “has moved astonishingly quickly and is now based on metrics near those seen at the peak in 2007,” according to a Partners Group report published in August. The firm manages about e2.8 billion in non-core private equity real estate strategies.
At the same time, gross domestic product growth rates in Europe, the U.S. and developed Asian markets are “flattish,” said Mr. Angeloz, who is based in Zug, Switzerland. “We also see inflation as a threat on the horizon,” he added. “These two elements are not ideal for core real estate.”
In a rising interest rate environment, he added, leveraged core investments — particularly trophy assets — will have less “margin for error” compared to value-added or opportunistic properties in obtaining attractive returns, Mr. Angeloz said. “Now is the time to invest outside of the core space.”