One of the big shake-outs from the financial crisis has been a strategic shift by institutional fund managers from traditional property sectors into so-called alternative investments, and this move is gathering momentum. Allocations to alternative real estate, such as healthcare, leisure and residential, have more than doubled over the past decade and now account for 11% of assets, by number, in the £109bn Investment Property Databank (IPD) All-Property Index.
In the post-financial crisis era of low gilt yields, institutional investors have turned to these properties as a means of generating long-term income returns, and they have been handsomely rewarded. Factor in capital growth and they have comfortably outperformed commercial property, especially over the past six years.
IPD categorises this disparate group of assets – which is dominated by leisure but covers everything from agricultural land to education and parking – as ‘other’ and it has produced average annual total returns of 8.5% over 12 years (see line graph). That performance places ‘other’ second only to residential, which has generated average total returns of 10.7% and is still considered by many institutions to be an alternative asset class.
Alternative values outperform
Either way, as Mark Weedon, IPD’s vice- president and head of alternative invest-ments, says: “All of these sectors have held their value much better than commercial property does, particularly residential, but also healthcare and hotels.” With such impressive returns it is easy to understand why many in the industry expect alternative property allocations to carry on rising.
In a recent Jones Lang LaSalle survey of fund managers and investors, 79% of respondents expected weightings to alternatives to reach 15% by 2023, with more than a third of them predicting weightings of 25% or more. Student accommodation is set to see the biggest boost, with 70% of respondents keen to increase exposure, followed by private rented housing (65%) and hotels (64%). At the same time, many respondents intend to disinvest from commercial real estate to some extent due to competition and decreasing supply.
According to IPD, that disinvestment from mainstream assets has been evident for more than a decade. In 2001, when alternatives made up 4% of IPD, retail allocations were 46%, but they have since fallen to 38%, while allocations to offices have dropped from 26% to 23%. This shift into alternative sectors is by no means restricted to the UK. Figures provided to Real Estate Capital by research firm Real Capital Analytics reveal that since 2008 there has been significant growth in investment for data centres, senior housing and student accommodation across Europe, albeit off a low base (see chart).
Weedon points out that the specialist operators, particularly in healthcare and student accommodation, are building and buying new stock to increase the size of their funds as well as enjoying stable or appreciating capital values of existing stock. But he adds: “The institutional investment community is genuinely more interested in these areas and genuinely investing more money in them, and I think that will continue coming through.”
This trend will continue, he argues, despite an improving performance and outlook for commercial property. “The mainstream institutions are moving very slowly, but still surely, away from the direction of core commercial,” Weedon says. “Even if it has had a better year, it is much more cyclical. I think a lot of large investment organisations have now realised and accepted that they need to invest in something else for better returns.
“There’s still pain to be encountered in core commercial properties. There’s still a large legacy of upward-only rent review leases that were signed on 20- to 25-year terms, which still have a number of years to run, where the rental value is already significantly lower than what the tenants are paying.”
For David Batchelor, executive director of CBRE’s specialist markets team, alternative assets is “an annoying tag” that does not reflect or serve his clients’ interests. He favours “operational real estate”, where the value of the property is directly driven by the operational performance of the business within it. “For us, that means healthcare, hotels, pubs and leisure,” he says.
Opportunistic players lead the way
As Batchelor points out, operational real estate is not an obvious option for many risk-averse UK institutions that have traditionally preferred “bland covenant investments”. However, he says equity-rich opportunistic investors have no such qualms, especially over the past year when yield compression has made prime commercial property look expensive.
Batchelor adds: “If you’ve raised your pile of cash saying you are going to get 8-12% returns, it is getting harder to do that in the mainstream, so you’re forced to look at the more alternative sectors. We’ve had more of these opportunity funds starting to come into healthcare, leisure and pubs.”
One such investor is Palmer Capital, which has gone for petrol stations and most recently residential development land – bought speculatively and sold with planning permission to housebuilders. For chairman Ray Palmer, it is simply about “going where we perceive there to be value” rather than any concerted push into alternatives. As he says, many investors categorise property generally as an alternative investment anyway.
That said, he believes Palmer Capital’s development activity – not least a science park proposal for the former Astra Zeneca headquarters in Alderley Park, Manchester – an be bracketed as alternative. He points out, too, that many of Palmer Capital’s funds are backed by local authority pension schemes – not hitherto regarded as the most adventurous investors. He says: “It is not an institutional enthusiasm for any one particular type of property, it’s an institutional enthusiasm to try and get extra returns from being opportunistic. Because of that, alternative uses loom large in the equation.”
If even local authority pension funds buy into the alternative assets sector then it can only support the view of L&G’s research director, Rob Martin, that alternatives could account for as much as 30% of IPD in a decade’s time. As for an alternatives sector of the future, Martin believes that senior living is one to watch. “We haven’t delivered the models yet but there is a very clear need to provide a better kind of accommodation for people as they grow older,” he says. “That’s an important part of resolving some of the shortages we have in generic residential assets across the UK.”
Martin acknowledges that this is another area where the lines of investment are blurred between retirement villages, assisted living and extra care housing. However, he adds: “They are all basically about trying to live as independently as you can with some assistance when you need it, be that health or social care. I think the potential for that is massive in this country.”