Those of us of a mature vintage remember real estate’s glory days as a core asset class, when it accounted for 15-25% of pension fund and life company portfolios. Now it accounts for just 1.9% of total funds under management (IMA, January 2013) and it is lumped in with hedge funds and venture capital as an alternative asset class by policy makers under the EU Alternative Investment Fund Managers Directive and other rules.
But there is a great opportunity for the property investment industry to push its case for featuring more heavily in investors’ portfolios. People’s need for long-term financial planning and investment is more pressing than ever, with increasing numbers having inadequate retirement provision. Also, the move to defined contribution (DC) pension schemes is exposing investors to investment risk. Real estate is an attractive long-term option for investors because its low or negative correlation with other asset classes provides diversity and mitigates risk. Even if you acknowledge that property valuations smooth over market movements, and adjust accordingly, volatility is still much lower than for many other ‘alternative’ assets.
While interest rates are at an all-time low and with UK gilts getting a credit downgrade, property offers relatively high and stable income and long- term growth, with default risk mitigated by the ability to relet assets. Thus it is a strong contender as part of an individual’s long-term savings. The challenge is to build an understanding of the asset class and its role in helping people build a secure financial future – with regulators, policy makers, advisers and ultimately investors. The Association of Real Estate Funds (AREF) has been doing a lot of work to educate policy makers on property’s merits. But regulators are wary of illiquid investments, believing that only more liquid products will protect retail investors, as they can take their money out quickly if needed.
This may not suit investors’ objectives and the cost of liquidity in a relatively illiquid asset can adversely affect long-term returns. People wanting access to ISAs may not need the same liquidity when making longer-term pension provisions. As has been widely reported, Solvency II capital requirements for property are too high, being based on limited, inappropriate data that makes real estate look less attractive to insurers. Less well reported were proposals by the European Insurance and Occupational Pensions Authority to transpose chunks of Solvency II into the Institutions for Occupational Retirement Provision (IORP) directive, including the 25% capital requirement, despite IORPs being very different to insurers.
Again, the regulator favoured liquidity protection when consulting on linked, long-term insurance business early last year, not recognising the utility of real estate qualified investor schemes as appropriate vehicles for linked business. Late last year, the FSA consulted on proposals to ban promotion of unregulated collective investment schemes (UCIS) to retail investors. The need to protect mass market investors from unsuitable products is understandable, but is a promotional ban the solution to concerns that essentially arise from miss-selling? Investors should be entitled to invest in UCIS if they know and understand the risks, and want to diversify to spread risk.
More positively, the European Commission plans to promote long-term investment as part of UCITS VI. AREF would like to see a complementary regime for long-term investments that includes real estate funds. AREF’s work to resolve issues in the Property Authorised Investment Funds regime is also bearing fruit; we are seeing conversions of large, mainstream funds that are tax efficient and fully authorised for sale to private investors. These should provide further options for DC pension providers and enhance ISA investors’ returns, once investment platforms have been adapted to accommodate multiple income streaming. Policy makers’ failure to understand real estate could lead to inappropriate regulation. It is our role as an industry to ensure that widespread real estate investment has a long-term future.
John Cartwright is chief executive of AREF