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Prof. dr. P. van Gool FRICS

ERES 2013 Changes in the real estate asset mix of institutional investors; what will be the optimum for the future?. Prof. dr. P. van Gool FRICS Amsterdam School of Real Estate / University of Amsterdam / Dutch Railways Pension Fund / Pension Fund of Public Transport Friday July 5, 2013.

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Prof. dr. P. van Gool FRICS

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  1. ERES 2013Changes in the real estate asset mix of institutional investors; what will be the optimum for the future? Prof. dr. P. van Gool FRICS Amsterdam School of Real Estate / University of Amsterdam / Dutch Railways Pension Fund / Pension Fund of Public Transport Friday July 5, 2013

  2. Topics • The role institutional investors in the Netherlands • The real estate asset mix of institutional investors in the Netherlands • Changes in the real estate asset mix • What would be the optimum mix for the future?

  3. I The role of institutional investors in the Netherlands

  4. Pension income compared to last working income Level of net pension income Net replacement ratio (pension income divided by last earned salary)

  5. Poverty of elderly people Poverty amongst the aged percentage of those aged 65+ with an income of less than 50% of the median income

  6. II The real estate asset mix of institutional investors in the Netherlands

  7. 9.5% of total assets in real estate with a mix of 30% direct and 70% funds (of which 52% non listed)

  8. Together with Finland the highest allocation towards real estate (end 2010)! Pension funds only!

  9. And the highest non domestic allocation! Yes, a small country!

  10. Dutch REIT sector is small! € 6bn Netherlands 5 Reits

  11. III Changes in the real estate asset mix

  12. Changes in the real estate asset mix in the Netherlands • From bricks and mortar (direct real estate) towards funds (indirect real estate) • Less in offices and more in residential and retail • More in non listed (private) real estate funds, but with challenges • More allocation of largest and smaller pension funds towards listed (public) indirect real estate • Open ended funds have to sell their assets • More joint ventures and club deals

  13. From bricks and mortar (direct real estate) towards funds (indirect real estate)

  14. Disappointing returns private funds

  15. Challenges private indirect real estate in 2009 and 2010 (I) 16 • New finance was unavailable • Renegotiating debts: (re) financing was difficult and sometimes required reducing leverage by forces selling of properties • No funding for developments and projects in pipe line • Leverage worked (and still works) negative • LTV (loan to value) breaches, forced selling and new equity required • Defaulting investors

  16. Challenges private indirect real estate in 2009 and 2010 (II) 17 • Fall of (rental) income (especially trading funds which couldn’t sell any more) • ICR (interest coverage ratio) breaches • Forced selling by open ended funds • Fund managers (providers) were not motivated (no performance fees); • Sometimes fund managers bankrupt due to other activities (mostly development activities) • Investors were in default (did not want to invest) • Fraud

  17. Goldman property fund posts 98% loss 16 April 2010An international real estate fund backedby Goldman Sachs has reportedly lost almostallitsequityfollowing the poor performance of investments in Germany, the US and Japan. The fund, Whitehall Street International, carried out highly-leveraged transactions during the real estate boom.The Financial Times saidthat the fund is down to $30 mln in equityfromanoriginaltotal of $1.8 bn (EUR 1.3 bn). Thiscorrespondedto a loss of about 98 cents to the dollar.

  18. Leverage had ‘horribly damaging’ impact on fund performance in downturn: ULI 15 January 2013 • The use of leverage had a ‘horribly damaging’ impact on property fund performance in the recent market downturn, new research from the Urban Land Institute (ULI) shows. • The negative impact of leverage was greatest for opportunity funds which showed the highest level of underperformance in the 2001/2011 period compared to core and value-added funds. According to the study, gearing led to 2.2% lower returns per year for every 10% of debt in a fund, equivalent to 13.2% per annum for a 60% leveraged investment. • The negative impact of leverage was also evident among value-added funds, which typically have more than 40% but less than 60% gearing and aim to generate some of their returns through active asset management. These funds significantly underperformed the market between 2008 and 2011. The research demonstrated that every 10% of leverage within a fund reduced annual returns by 2%. • Core funds, which typically have little or no gearing and invest in prime assets, performed the best of the three types of investment vehicles and closely tracked the underlying IPD market index until 2009.

  19. Development total real estate investments mix Dutch investors (in %): more allocation of largest and smaller pension funds towards listed (public) indirect real estate Pension funds Insurance companies Total Direct Indirect public Indirect private Source: Mosselman, 2013

  20. Substantial difference in real estate asset allocation largest 25 Dutch pension funds end 2011 (source M. Bakker, 2012) Largest pension funds have much listed real estate

  21. Outflows prompt UBS tofreezeGerman open-ended fund 11 October 2010 Swiss bank UBS saidonMondaythatit is haltingredemptionsfromits UBS (D) 3 Sector RealEstateEuropepropertyfundon the back of growingredemptiondemandsfromitsinvestors. The vehicle, which had re-opened in October 2009 after over a one-yearredemptionfreeze, willbesuspendedfor a period of 12 months, UBS said. The fund is managedby UBS' Munich-based KAG fund management unit. According to UBS, the largeoutflows in the fundweremostly a result of the proposedchanges in legislationforGermanopen-endedrealestatefunds as well as recent developments in the Germaninvestmentmarket, such as the dissolution of KanAmUS-grundinvestfund. What do you think?

  22. IV What would be the optimum mix for the future?

  23. How to make the perfect real estate mix? Asset-only approaches: Based on the past: Sharpe ratio maximization The Sharpe ratio is calculated by subtracting the risk free rate from the rate of return for a portfolio and dividing the result by the standard deviation of the portfolio returns. So the higher the Sharpe ratio is, the better. Risk minimization Partly based on the future: Risk and return models with forecasted real estate returns and risk scores of different markets, sometimes with historic correlations ALM (asset liability management studies); forecasted return with historic relations Look in a crystal ball:

  24. What would be the optimal mix with the following possible portfolio? • Direct real estate • IPD index figures, standing investments, IPD-ROZ for the Netherlands, smoothed and unsmoothed, no leverage • Indirect listed (public) real estate • GPR general index World, total return in € (including leverage) • Indirect non listed (private) real estate • US NFI-ODCE (NCREIF Fund Index – Open End Diversified Core Equity ) with 40% leverage (proxy for INREV data, only available after 2001) • Risk free rate (for Sharpe ratio calculation) • 10y state € swap rate

  25. Outcome of Sharpe ratio optimization(past figures) Optimum: most of the portfolio in direct real estate or most of it in private real estate!

  26. Optimum with a ALM model • Not one optimum but several possibilities! • Optimum % real estate of total portfolio: 15 – 30% With more different alternative asset classes (commodities, infrastructure, private equity etc.) the optimum real estate % is lower! • Optimum real estate mix between: • Direct real estate: 0 – 50% • Private (non listed) real estate: 50 – 75% • Public (listed) real estate: 25 – 50% Why is there a range of optimal mixes? Perhaps smoothed assumptions (input in the model) and many more other assets which don’t correlate with each other?

  27. Always a trade-off between risk and return! (Epra sponsored) research (Harvey & Cheigh and Eichholtz) shows superior returns public real estate vs. direct and private indirect, but don’t mention high volatility and correlation with (normal) equity!

  28. Risk and return model CBRE Global Investors Global office markets Forecast total return (2013-2016) Real Estate Investment Risk Score (based on structural and cyclical risk factors

  29. Concluding remarks • In the battle between direct and private real estate, direct real estate wins (no leverage, less governance issues and more liquidity), but you need a substantial portfolio. • In the battle between private and public indirect real estate, public real estate gives higher returns, better quality assets, more spread in the portfolio and much more liquidity, but more volatility and correlation with normal equity.

  30. Choice depends on: • Volume of investments (assets under management) • Access to and quality of real estate management • Willingness to get your “hands dirty” by managing direct real estate (risk of fraud) • Where do you want to invest; national or international scope? • Accepted correlations with other assets • Risk / return profile wanted (core, core+, value added, opportunistic) • Accepted (non) liquidity and time horizon

  31. Thank you for your attention Prof. Dr. Peter van Gool Real Estate Economics @UvA, MD Real Estate @ SPF Beheer

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