23/09/06
Fundamentals - Property – Still a local business?
Commercial property markets are not immune to the growing phenomenon of 'globalisation'. Real estate investors are increasingly looking outside their domestic markets in search of better value. Does this imply a collective agreement that property markets around the world are over priced?
Over the last few years we have observed three trends emerging with pension funds investing in commercial property. Firstly, an ageing population and a fundamental shift to a more liability driven approach have pushed pension funds to increase their target allocations to commercial property. In 2000, pension funds typically invested 5% of their total portfolio in UK property. Whilst many have increased their exposure to property the majority remain substantially short of their increased target allocation to the asset class. A second trend resulted as funds recognised that, not only was it difficult to gain access to a finite domestic property market, but also some European markets offered potentially better value and higher income yields. As a result, the number of pan-European private property vehicles, available only to institutional investors, has more than doubled in the last five years. The most recent emerging trend has been global real estate diversification. Underpinned by strong economic growth in Asia and the development of tax transparent vehicles, which allow relatively easy access to international markets, UK funds have been expanding their investment universe outwith Europe.
On average, the UK commercial property market looks increasingly expensive, even though some areas of the market such as Central London offices should perform well over the next couple of years. UK property's income yield has declined sharply in recent years driven by exceptional growth in capital values and investor demand for stock. This year yields have fallen below debt finance costs for the first time since 2000 and the gap between government bonds is at its narrowest point for 10 years. Although eurozone markets do not look as costly, the sharp increase in interest rates has now eroded some of their historic attractiveness. The more mature Asian office markets such as Tokyo and Singapore offer Sterling based investors with a higher yield, after currency hedging, than that found in Western European markets with the prospect for good rental growth.
Other than investing in overseas property markets where investors perceive prices to be more attractive, there is a further more academic reason for investing globally. Economic, property rental and listed real estate stock data across markets such as Hong Kong, Tokyo and Singapore displays little or negative correlation with Western European markets. Hence they provide good diversification benefits for investors.
Few investors would argue that buying buildings in unfamiliar foreign property markets is a risky business. Detailed knowledge of local tax regimes, land ownership rights, planning policies and leasing practices are just some of the potential stumbling blocks. In recent years such issues have been tackled with two different approaches. Some investors have pooled their capital together in partnerships allowing legal, tax structures and fund manager costs to be shared. Although not as liquid as property shares, these vehicles can closely follow returns from the underlying markets. The huge growth in real estate investment trusts (REITs) has also facilitated the growing appetite for global property exposure. Investors can buy a tax transparent share of a listed, and therefore highly regulated, company with local market expertise. Although more volatile because of their equity market correlation in the short term, these stocks are highly liquid and cheap to buy and sell.
Property might still be a local business but global investors can now tap into markets by investing with adept fund managers or by holding listed stocks of domestically run companies backed by native expertise.
Andrew Jackson, Fund Manager – Select Property Fund, Standard Life Investments
First published in The Herald on 26 August 2006.
Standard Life Investments Limited, tel. +44 131 225 2345, a company registered in Scotland (SC 123321) Registered Office 1 George Street Edinburgh EH2 2LL.
The Standard Life Investments group includes Standard Life Investments (Mutual Funds) Limited, SLTM Limited, Standard Life Investments (Corporate Funds) Limited and SL Capital Partners LLP. Standard Life Investments Limited acts as Investment Manager for Standard Life Assurance Limited and Standard Life Pension Funds Limited.
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