M&G launches first European fund to offer inflation-linked protection, writes Jane Roberts.
European pension funds are keener than ever to find low-risk investment alternatives offering a premium to measly-yielding bonds as the continent’s rock bottom interest rate environment shows no sign of changing soon. Core property fits the bill and is even more welcome if it offers that premium wrapped up with inflation-protection and long leases, matching funds’ long-term liabilities.
M&G Investments is capitalising on the demand with a new fund, the first of its kind, which will build up a pan-European portfolio of long-leased assets with inflation protection.
At launch last month, five continental European pension funds had committed €265 million to M&G European Secured Property Income Fund (Euro SPIF).
The open-ended, euro-denominated fund will invest on the continent, ex UK, and M&G hopes to quickly build on the success of its UK SPIF product, which is managed jointly by M&G’s fixed income and real estate divisions, has an identical strategy and has attracted billions of pounds of capital, amassing £3.2 billion of assets from a standing start eight years ago.
M&G had wanted to replicate UK SPIF on the continent for some time. Partly there was an in-house hurdle, which was building up a track record for investing in Europe and having enough boots on the ground to scour jurisdictions for the best deals.
It was also about being confident of a flow of long-lease transactions. Alex Jeffrey, chief executive of M&G Real Estate, says long-lease property is not as established in continental Europe as in the UK though it is evolving. Euro SPIF is therefore “an innovative fund that will enable investors to access an evolving opportunity at a time when the European economy is improving”.
M&G will find deals from operating companies looking to raise capital from their real estate while retaining long-term occupational security over their key assets, and interested in a sale and leaseback option. One reason sale and long-term leasebacks are more attractive to them is that their set of alternatives has reduced now that banks have largely retreated from long-dated financing.
“A new European financing landscape is emerging following the financial crisis”, says M&G Investments’ fixed income chief executive Simon Pilcher. One “where pension funds and institutional investors, the natural owners of long-term capital, are providing long-term finance where banks previously dominated the market.”
Euro SPIF’s fund manager Ben Jones says a property sale and leaseback can also be an alternative to raising finance in the bond markets for some operators. “In particular, private equity owners wishing to release capital from real estate, when their profile means they are not necessarily natural bond market issuers. A sale and leaseback transaction where the rent is set at a conservative level of gearing versus Ebitda generation of the assets allows them to access attractive long-term finance rates,” Jones says.
Setting rents at the right level at the outset is key: there were high-profile casualties in sectors like nursing homes in the wake of the 2008 crash, in leveraged ‘opco-propco’ structures with rents that turned out to be unsustainable. Euro SPIF will seek relatively conservative real annual returns, mainly from income though hopefully with some capital growth, of 3-4 percent over inflation, and is likely to have a basket of different inflation measures depending on the assets its acquires.
One source of deals, Jones says, will be existing UK SPIF relationships. One of the fund’s two maiden deals is acquiring the David Lloyd health and racquets club in Brussels – the most profitable in the chain – for about €50 million, on a 30-year, triple-net lease linked to Belgian CPI. “The opportunity came off the back of completing a £350 million UK transaction with them”, Jones says, referring to UK SPIF’s acquisition last year of 44 UK health clubs.
The second acquisition is in Portugal and is a portfolio of 12 supermarkets sold and leased back on 20-year leases to Sonae. Euro SPIF has taken five of the assets, valued at about €50 million, while the remaining seven have been acquired by M&G Real Estate’s European Property Fund in a joint €164 million deal. There’s a third in the pipeline of German commercial ground rents and another in Dublin.
“In the UK our focus evolves as pockets of relative value shift”, Jones explains. “We were an early investor into budget hotels and supermarkets. Other investors have come in and we saw those yields compress. Then we started investing in student accommodation, and other operational assets like healthcare and leisure.”
It’s a product that other fund managers would love to have. The chances are billions of euros of capital will flow this way in the next few years, if the opportunities can be structured.