U.K. pension funds eyeing a buildup in domestic residential real estate

The U.K. residential real estate industry has endured some serious uncertainty in recent years amid high inflation and the knock-on impacts of Brexit — but there may be signs a rebound is on the way.

Interest rates are falling and the U.K. government’s recently elected Labour Party is pledging to build 1.5 million new homes in the U.K. over the next five years.

There could then be nascent signs that now is the time for investors to get involved in the U.K. residential sector. For U.K. pension funds, such a move would also dovetail with the Mansion House Compact, a 2023 government push to get funds back investing more in the U.K. market, and similar such drives by Rachel Reeves, current U.K. chancellor of the exchequer.

Institutional capital

There's been a flurry of recent activity among U.K.-based institutional investors. ACCESS Pool, Essex, England, is currently undergoing a search for an investment mandate in U.K. social housing, according to an annual statement published in September.

ACCESS member funds are local government authorities, and made up of 11 separate U.K. counties including Cambridgeshire, East Sussex, and Kent. As of March 31, ACCESS had assets of £45 billion ($57 billion), with 20% invested in the U.K. across all asset classes.

“ACCESS Authorities are long-term investors and have continued to invest heavily in the U.K.,” said Alistair Coyle, client manager for ACCESS Pool, Essex, England. “A large portion of this is currently through real estate, and we envisage this share to grow as our asset pooling project continues. We expect this to take five years, potentially longer, for our clients to fully transition their existing real estate holding to the pooled solution in the most efficient and risk advance way possible.”

Shamez Alibhai, head of community housing and managing director at Man Group, which had $175.7 billion in assets under management as of March 31, noted that the U.K.’s local government pension schemes have been very active in the nation’s residential sector, and have been “very progressive” in their approach.

In July, LGPS funds in the U.K. invested a collective £150 million into an affordable housing fund run by U.K. investment firm Octopus Investments. Edward Clough, managing director for real estate at Octopus, which had £13.5 billion in assets under management as of March 31, said: "We have raised a lot of money from LGPS funds over the last year, which is really positive and underpinned by a strong demand, to deliver positive social outcomes in the U.K., though areas such as affordable housing and care homes."

In October, the £30 billion LGPS Central, Wolverhampton, England, a pool of eight local government pension funds in the U.K., also committed £40 million into PGIM Real Estate’s U.K. Affordable Housing strategy.

Yet Alibhai also stressed that 300,000 homes would need to be built a year for the next five years in the U.K. to reach the government's 1.5 million target within its timetable, at a cost of hundreds of billions of pounds, “more money than the LGPS sector can deploy.”

As for the wider U.K. pensions sector taking on the challenge, Alibhai estimates that within a typical defined contribution fund allocation only 25% would go toward private markets, and only 2% to 2.5% of a total portfolio going toward the residential sector.

By comparison, according to data published by Schroders, the average defined benefit allocation to U.K. equities has fallen from over 50% in the 1990s to less than 2% in 2022. FTSE 100 listed companies include major U.K. home construction firms Taylor Wimpey and Persimmon.

With the U.K. annual fiscal budget statement coming later this month, industry body the Association of Real Estate Funds has warned that if defined contribution investments in the illiquid sector do not fill the gap left by the decline of defined benefit pension fund investments, there “will almost certainly be profound consequences. Growth funding to build more homes will be more difficult, as will financing the net-zero agenda through retrofitting.”

There is also the question of exactly how institutional investors should go about putting money toward residential investment, especially in a sector hit hard in an inflationary environment and with other classes such as U.S. equity outperforming.

“It’s fair to say the fundraising environment has been slower, especially over the last two years,” Clough said. He also pointed out that the U.K. was hit harder and sooner than other developed economies, due to factors including the fallout from Liz Truss’ 2022 mini-budget.

There are signs of recovery. Real estate investment trusts will benefit from falling interest rates, with September commentary from Principal Asset Management noting that declining yields will reduce discount rates and boost the value of future cash flows.

“2024 may well be looked upon as a golden vintage for real estate. The combination of repriced assets, strong fundamentals in certain sectors and an ongoing limited liquidity environment make for an attractive investment entry point to the market," said Lee Marshall, head of real estate at the Pension Protection Fund, London.

The PPF is the £32.5 billion lifeboat pension fund for the plans of insolvent U.K. companies. Currently, 6% of PPF's portfolio is real estate, and of that 6%, 10% percent is in U.K. residential, making for 0.6% of overall portfolio.

Bill Page, head of real estate research at Legal & General Investment Management, which has global assets under management of $1.4 trillion as of June 30, also sees the current moment in real estate as occurring at the end of a long tailwind: “When inflation started to increase, and the U.K. was working its way through COVID, real estate looked relatively expensive compared to other asset classes. Investors were instead getting good yields on low-risk fixed income, and equity markets were not too bad, either.

“That started to change in 2023 as real estate values corrected. At the start of this year, real estate began to look fair value compared to other asset classes and in Q2 it moved into what we call cheap territory. Right now it’s better than fair value,” he said.

In September, £36 billion workplace DC plan National Employment Savings Trust, London, partnered with Legal & General Investment Management and PGGM in a deal aiming to collectively invest up to £1 billion in the U.K. build-to-rent sector. The partnership is initially backed by a £350 million combined investment.

“If you look at the U.K. residential sector, there continues to be significant undersupply of housing and a great need for capital to support new supply," said Lama Kanazeh, global head of real estate business development at Blackstone, a global alternatives firm with more than $1 trillion in AUM.

"Private capital can play an important and positive role to help address the issue of undersupply of housing, which is driven by both long-term structural as well as demographic trends,” she said.

For example, through Sage Homes — an affordable housing provider in the U.K. founded by Blackstone and residential real estate investor Regis Group — the firm has committed about £4 billion to fund the development of 22,600 affordable housing units, of which 17,000 have been delivered.

Varieties within real estate

Of course not all houses are created equal. A huge range of difference can be found in upcoming residential projects, targeting different demographics, regions and affordability of housing.

Man Group's Alibhai also emphasizes that housing should not be created in a vacuum, and that a common criticism of U.K. home building in the last two decades has been a lack of connecting infrastructure being constructed alongside, such as hospitals, schools and places to socialize.

Approaching these challenges is Jorge Duarte, senior managing director and fund manager of Hines European Property Partners, the Luxembourg-domiciled core-plus fund at the real estate investment manager. Hines manages $93.2 billion in assets, and HEPP has over €1 billion ($1.1 billion) in commitments.

“Demographics is at the top of considerations when exploring investing in real estate as we consider it to be a key structural driver of income, regardless of the sector in which we are investing in,” Duarte said.

He also identifies the impacts of climate change as a critical factor that influences long-term value, risk management and market competitiveness. This approach to real estate through a sustainable lens intertwines with impact financing, and the establishment of fixed income such as social bonds looking at this area.

Tammie Tang, head of Columbia Threadneedle Investments' social bond franchise, which reported global assets under management of $642 billion as of June 30, oversees investment in social housing as part of the portfolios.

“Social housing has played a material role in our funds. Real estate has also always been a natural place for institutional interest when it comes to impact because you can find some very interesting and compelling opportunities. It suits a long maturity profile, and the impact of something such as building housing for low-income earners can be very tangible,” Tang said.

When it comes to investing in the residential sector, Tang points out that when it comes to Maslow’s hierarchy of needs, housing is essential to one’s physical safety and security.

"We want capital to help and to go to where it's most needed", she said.