December 1, 2009 3:30 pm

A firm foundation for many investors

Hope springs eternal in the human breast. Although many fund managers have been bruised by turmoil in property markets over the past year or two, many now talk enthusiastically about its prospects.

Property assets are yielding double the income from bonds and banks and building society accounts.

Scottish Widows Investment Partnership (Swip) is making property the third leg of a new structure for its asset management division to sit alongside equity and fixed income funds. The division has £6bn under management – about 6 per cent of total assets – and Dean Buckley, chief executive, says it has plans to increase that substantially in the next year.

“On yields of around 7 per cent, property has to look attractive against government bonds and equities yielding 3.5 per cent,” says Mr Buckley. “True, it will be a long recovery and there is a lot of supply to come on to the market. But for most players, the challenge is to get into the market.”

There are still uncertainties, he adds. “The occupier side is more difficult. Rental values are under pressure.”

Nonetheless, Swip is one of a growing crowd of asset managers for whom property is an increasingly important asset.

John Fraser, head of UBS asset management, this month outlined his desire to add to the UBS real estate fund business, in spite of being forced to freeze three real estate German funds at the height of the crisis.

Larry Fink, founder of BlackRock, one of the world’s biggest fund managers, recently outlined the rise in optimism, albeit with some caution about commercial real estate. He noted that for the first time in a year, investors are looking to invest in the market.

Some of the world’s biggest pension funds are also seeking to raise their allocation to property, even in the US where the property market is still lagging.

The California Public Employees Retirement Scheme, the biggest of its kind in the US, is already one of the biggest investors in housing and undeveloped land in California and its performance has suffered accordingly. This summer it reported its worst returns in its 80-year history. Its investment in LandSource Community Development, a housing partnership that fell into bankruptcy in 2008, cost it close to $1bn. This prompted the board of the fund to put in place new rules to govern the managers.

But in August, the California fund’s board signalled a return to optimism when it sanctioned the purchase of 86 US shopping centres for about $1.73bn less than it received for the same portfolio four years ago. It was Calpers first significant real estate deal in more than a year.

Joe Dear, chief investment officer, warned at the time that the worst was not over. However, he was sure that assets such as real estate, private equity and infrastructure would deliver higher returns to pension funds than equities over the long term.

Calpers is one of the standard bearers among pension funds. Hermes, manager of BT’s pension fund, the UK’s biggest retirement scheme, invests about 10 per cent of its £30bn in funds in property against an average of about 7 to 8 per cent among its UK peers. The fund began to raise this about three years ago because property has the characteristics of both bonds and equities, is a hedge against inflation and a useful way of diversifying risk while boosting income. Hermes points out that for pension funds, promising an inflation-linked income to pensioners, property is increasingly useful.

This long-term shift in asset allocation is different in tone from what may be a more ephemeral change in private investors’ appetite for property funds highlighted recently by the UK’s Investment Management Association.

It said last month: “Property funds had net retail sales totalling £261m in September, more than double the £129m achieved in August, and the highest since June 2007 (£307m).”

It added: “Property funds have had positive net retail sales for the six consecutive months now, the first time this has happened since 2007.”

These inflows are prompting a number of fund managers to put behind them the difficulties they had in property last year and look once more at launches. Aviva Global Investors and Standard Life Investments, long-time stalwarts of the property market, are both looking at launching property funds hoping that the market has hit its bottom. After all, they say, commercial property in the UK has fallen by more than 40 per cent from its peak in June 2007. Some researchers such as IPD, say July figures show some sectors of the market are beginning to recover for the first time in two years.

Anne Breen, head of property research at Standard Life Investments, points out the IPD index has risen more than 1.5 per cent since August. “Interest in central London commercial offices is positive, and tenant demand for good space is improving.”

Declines in rents are slowing. Meanwhile, the construction pipeline is still tight. Against this positive backdrop, and with cash and equity yields so low, it is not surprising demand for property is escalating.

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