A carefully thought-out investment strategy is helping to drive real estate growth at Prudential’s investment manager, M&G, with property head Alex Jeffrey set on building a portfolio that will stand the test of time, he tells Jane Roberts
If the summer’s reality check for property has had any lasting effects, they aren’t being felt yet at M&G Investments. Concerns over the potential for China’s economic slowdown to affect other markets, plus record low real estate yields in some locations, particularly for prime UK assets, have set off a debate on whether real estate markets have peaked.
But three years into the role, AlexJeffrey, M&G Real Estate’s chief executive, is enjoying an extended honeymoon with investors still queuing at his door, though he stresses that, more than ever, M&G remains a conservative and careful investor.
Few are more qualified to give a view than Jeffrey, who took on oversight of real estate at the mighty Pru’s investment management arm and its £22.5bn of European and Asian bricks and mortar assets, in summer 2012, from the widely- respected Martin Moore. Most recently before that, Jeffrey had been at MGPA, latterly based in Singapore, and before that in Europe.
He’s well aware that the wave of Chinese money might recede. A Chinese buyer failed to clinch a £455m deal for Broadgate Quarter in the City of London in October, letting Blackstone snap it up for a reported £415m. The building’s tenant, law firm Ashurst, has pre-let a nearby M&G development, the Fruit &Wool Exchange.
“We saw a slight slowdown in flows during August but it’s picked up again,” says Jeffrey. “Our asset sales have been going through – we haven’t seen a buyer pull out. Some high-profile central London deals have fallen over, mainly involving Asian buyers, but we haven’t seen any of that.
“We also haven’t seen pricing softening – we still see returns moving forward quite strongly. I think the reason is that the US economy in particular is strong, sentiment is high and confidence is right up there.”
While M&G’s clients are not losing their appetite for property – “quite the opposite” – Jeffrey says demand from both internal and external accounts is “probably stronger for Continental Europe and Asia than the UK, possibly because of the perception that the UK is further through the cycle. But there is still a very positive flow into the UK. We’re especially seeing flows into our UK retail- investor, long-income and residential funds.”
M&G’s bricks and mortar business – it also invests in property debt, that side of the business led by John Barakat in fixed income – has three main strands. Jeffrey’s team invests for European, UK and Asian core/core-plus, open-ended funds; for in-house clients; and for external separate accounts. Notable in-house clients are the Pru’s UK life fund, annuities funds and Asian life funds in Hong Kong and Singapore.
Some in-house money is invested in M&G’s funds, some directly and some in other managers’ products – “we act as the Asian life funds’ internal multi manager”, Jeffrey says. Jeffrey targeted external separate account mandates as an area with potential for significant growth when he joined.
Few legacy problems
In the late 1990s and 2000s, unlike rival property investment houses, M&G eschewed closed-ended, specialist-sector funds and anything other than low gearing, so it has had fewer legacy problems.
Its pan-European and Asia funds have circa 20% gearing, “for moderate return enhancement”, which might be increased to 30%. Regarding leverage, Jeffrey says: “We’ll remain very conservative because we’ve all seen what happened in previous downturns, especially the most recent one. People with high leverage burned their fingers. It’s fine if you get capital out in time, but someone’s always left holding the parcel when the music stops and it tends to be the person who’s most highly leveraged.”
He doesn’t want to change much in the business model he inherited, continuing to focus on income above all, investing in high-quality, income-producing assets in markets the team knows, aiming to deliver sustainable high single-digit returns, whether from open-ended funds or separate accounts.
This doesn’t mean buying only stabilised, income-producing assets. Up to 20% of the £10bn UK life fund can be allocated to development, some of it speculative, and £700m of offices are going up in UK cities such as Reading, Edinburgh, Glasgow and Leeds, as well as the pre-let London Fruit & Wool Exchange in Spitalfields.
“Sometimes a large fund needs to take risks to keep renewing stock,” he says. “It’s to create assets to hold long-term, we don’t do it for development profit – that’s a bonus.”
When M&G’s €1.1bn European Property Fund is big enough, depending on the stage of the cycle, it will do the same. That fund’s first Spanish venture is a 377,000 sq ft Madrid office development on Calle Rios Rosas, a deal closed this year and worth up to €175m – although the risk is largely reduced due to a pre-let to global marketing group WPP.
However, Jeffrey does plan to take M&G’s property strategy to a wider investor pool, capitalise on synergies and explore new opportunities, while continuing to expand the existing funds and portfolios. Further investment is going into the international business while continuing to support growth in the founding UK platform.
In the UK, M&G has several “category- killing” funds, built up in the past 10 years, notably its £4.1bn, daily-priced, balanced property fund accessible to retail investors – “the largest UK property fund, bar none”.
M&G’s UK long-dated, inflation-linked Secured Property Income Fund (SPIF), managed jointly with the fixed income business, has grown rapidly since inception and is now worth £3.0bn. So far it has delivered in excess of its 4% over RPI return target.
In contrast, the European Property Fund began life slowly in 2006, an inauspicious time, but M&G’s and its 32 investors’ positive outlook for the Continent means “it’s getting a new burst of life”, Jeffrey enthuses.
The fund took in €300m of new capital from external investors this year and “a whole range of new investors want to come in. It’s got a strong track record, a great team on the ground across Continental Europe and we’re also seeing flows of capital from internal investors.”
Deal flow has been good and performance is starting to pick up. “We see value in some major cities’ high-street retail and acquired assets in Copenhagen and Milan recently, as well as high-quality, grocery-anchored, out- of-town retail, especially in Germany. Also state-of-the-art, well-located logistics assets.”
Value in Southern Europe
“We see some value in Southern European office markets, which are recovering off a very low base, like the Madrid deal,” adds Jeffrey. At some stage, the fund may invest in Poland.
Simon Ellis was promoted to deputy fund manager, supporting David Jackson, while Olivier Vellay, a former MGPA colleague, started in November as head of Continental investments. “We’ll hire an assistant fund manager in Paris and a senior investment manager in Frankfurt,” Jeffrey says, adding that M&G also plans to “add real estate people in the Stockholm office and extend a southern European office – probably Madrid – to real estate. So we’re gradually extending our capabilities across Europe and we’ll extend our team in Paris and move offices.”
M&G wants EPF to be one of a handful of leading open-ended, pan-European funds. “I don’t want to put goals on each fund, but we have strong ambitions for that one; there’s no reason why it can’t grow to a multiple of its current €1.2bn size in five years.”
A new Continental fund, which will extend M&G’s long-income investing strategy beyond the UK, is next in the works and is about to be launched.
M&G is not the only investment house to believe Continental institutions need long-dated, secure, inflation-linked income to match their liabilities. But this strategy is not easy to operate, as some European countries are less landlord-friendly than the UK and longer leases are the exception not the norm.
“But in building the UK SPIF portfolio, we had to manufacture most situations and leases by talking to occupiers, many of whom had never considered selling and leasing back properties. A similar approach will probably be of merit on the Continent.
“I think there’s a big opportunity, not least because owner-occupied property is a significantly higher percentage than it is in the UK, so there’s a lot of high-quality assets to potentially go for.”
M&G’s eight-year-old M&G Asia Property Fund (APF) has also been growing recently on the back of a patiently acquired track record and its managed assets in the region topped $2bn in five countries this year.
Shortly after Jeffrey arrived in 2012, M&G added real estate offices in Japan and South Korea to its long-standing Singapore base; three years later, the 50 or so staff moved to bigger premises in their respective markets.
Last year, the fund invested nearly $500m, in logistics, offices and residential. This summer M&G spent $230m on three South Korean retail assets leased to Lotte Shopping. A fourth Asian office opening is on the cards – the real estate arm doesn’t have boots on the ground in Australia, a big capital source and one of the fund’s five markets.
Potential for Asia funds
“As in Europe, we see the potential to create pan-regional, open-ended core funds for investors to access Asia’s market and ours is the largest and probably the longest- standing in the region,” says Jeffrey.
“Again, we’re looking for high single-digit returns and we’ve been able to do that consistently.There is strong competition for core investments across the world and certainly in Asia. You’re not just competing against other core funds, but local investors in most cases. So you need a good network to source deals off-market and follow research carefully as to where you’re investing.”
On the latter point, M&G thinks Tokyo offices are fully priced so has bought in Osaka and Fukuoka instead. It has resisted the pull of China – “that’s not in the near future” – and is sticking to its knitting.
APF includes Asian investors and in-house money alongside UK and European capital, but “at some point may become attractive to US institutions as well”, Jeffrey believes.
US investors haven’t featured much in M&G’s real estate funds so far, apart from the debt investing business, partly because M&G lacks a strong distribution base there and partly because US institutions usually invest in international property for additional yield rather than core/core-plus returns.
However, M&G’s property chief thinks that may change. If it does, targeting investors in the world’s deepest capital pool will be another way to expand the business. “Going into a new capital-raising market brings compliance challenges, so we’ll make sure that we do it in a co-ordinated way with the rest of M&G,” Jeffrey adds. “There are fixed-income, debt and infrastructure strategies that would look to access the US, so we’ll do it in conjunction with them, but there’s nothing immediately on the horizon.”
When he joined, Jeffrey said he wanted to increase external capital to 50% of managed assets, from 38% now. As part of the drive, Jeffrey’s focus is on building up third-party separate account mandates for big investors that, for whatever reason, are keen to invest this way rather than in funds.
Martin Towns moved from Prudential’s life fund to a new role as head of capital solutions at the start of the year, reporting to chief investment officerTony Brown. The “two or three” such clients when Jeffrey arrived have grown to “five or six” and the next step is to invest for them outside the UK. “It’s a huge opportunity because we have very strong deal flow and a great capacity to execute, which we can offer to a wider range of clients than our existing capital base.”
The UK deals have mostly been ‘sidecars’ alongside M&G clients, an example of expansion providing synergy with the existing business, as long as potential conflicts of interest can be managed.
In May 2013, for example, M&G’s SPIF partnered with China’s State Registration Fund to buy a 70% stake in the long leases of three Tesco superstores with a combined £237m market value. The retailer’s pension fund retained 30%. In June 2014, a deal was structured to buy two Manchester offices at 1 Spinningfields for £306m, with Prudential taking Spinningfields Square and a third- party account taking 1 Hardman Boulevard.
Matching the right capital to the right deal is one thing; also crucial, Jeffrey says, is “that we can be absolutely sure we know what they want to buy and that they will execute reliably. Our strongest asset is an unrivalled reputation for execution in the market and that’s not something I can take much credit for. It’s our policy not to chip the price and we deliver what we say we’re going to deliver, whether we’re a buyer or a seller. If we’re lending that reputation to an external investor we have to be absolutely sure that they’re going to do the same.”
Targeting UK rented housing
Another new part of M&G’s business, started under Moore and developed by Jeffrey, is investing in UK private rented housing, which European institutions hope may one day be an established market such as North America’s multi-family housing sector (see Special report, p24-25).
The M&G UK Residential Property Fund, managed by Alex Greaves, bought £200m- worth of assets in its first two years for a mix of in-house capital, and UK and Continental public and private pension funds, with more capital waiting on the sidelines.
While the fund accounts for less than one-hundredth of M&G’s assets under management, like other investors, Jeffrey and M&G see huge potential.
“The constraint for that fund is not capital but deal flow,” says Jeffrey. “That market has been the preserve of private landlords, so there isn’t the volume of large, private rented blocks to buy, or of the quality and in the locations that we need.
“So we’re mainly building property to rent in locations like North Acton and Bath and we’ve got a pipeline of other develop- ments, such that in two or three years’ time we’ll have a really high-quality portfolio of assets that are most importantly designed for rent, which is quite different from the traditional housebuilders’ approach.”
Most of the investment will be outside central London because the fund seeks an income-return component of about 4%. With capital growth strong for UK housing, it has so far delivered “significantly above” its high-single digit total return target.
While the UK private rented sector is in its infancy, the wider UK property market is seven years into the latest cycle. It is, Jeffrey believes, a potentially “perilous” time: “The UK is clearly a very crowded market. We’ve followed certain themes in an attempt to stay away from the crowd and acquire assets that will stand the test of time through the cycle.
“We are a long way through, so unless you’ve got a clear strategy as to where to invest and why it [will deliver] long-term value, it’s quite a perilous position to be in, chasing deals against all this other capital.”
However, Jeffrey doesn’t believe that just because we’re seven years into a cycle we’re riding for a fall. “That’s a simplistic way to look at things,” he says. “Downturns tend to be caused by a trigger. The bigger question is not ‘when is the downturn coming?’ because I don’t think anyone can credibly say, it’s: ‘how can you best prepare for it?’”
For M&G, he says, the answer is still “having the highest-quality portfolio with well-let assets and good-quality covenants, in good locations, which are well diversified by country, region, sector and tenants”.