Real Estate Benefits Within Reach For Smaller Plans

Authored By: Michael Peck | Publish Date: 04/10/2017

Pension plans, increasingly unsatisfied with low returns of fixed income assets and ongoing volatility of equities, have set their financial sights squarely on alternative investments, particularly real estate.

While the real estate market has typically seen peaks and troughs, the spectrum of real estate investment products both at home and internationally now ranks among the top of preferred investment opportunities.

A 2016 study by Greenwich Associates on Canadian institutional investor market trends suggests that money that had been previously earmarked for equities, particularly domestic equities, will continue to decline. Instead, the study predicts institutional investors will move into other assets, with real estate and infrastructure as the primary beneficiaries of those alternative allocations. In particular, the study pegged Canadian institutional investors’ three-year expected asset allocation changes rising 32 per cent for real estate investments.

Why Global Real Estate?

Real estate investments can provide several benefits to a portfolio of equities and fixed income. Directly held real estate can provide instant diversification, with a lower correlation to the stock market than listed real estate securities. It can also dampen volatility, as property values are not marked to market on a daily basis.

Real estate also has built-in inflation protection because the return on investment is tied to rents, which are designed to rise periodically. On top of that, expenses incurred by property owners are typically passed on to tenants. The stability and reliability of these income streams makes real estate an attractive alternative to fixed income allocations.

Real estate also significantly enhances diversification in general and holding non-domestic real estate serves to increase that benefit. There is often a home bias to investing, but Canada represents only five per cent of developed real estate markets.* Opportunities abound outside the country, especially in the United States, where the government recently amended its Foreign Income Real Property Tax Act (FIRPTA), making the U.S. real estate market more appealing to qualified foreign pension plans.

Liquid Bricks And Mortar

The availability of open-ended funds with relatively low minimum investment thresholds has made direct global core real estate more accessible than ever, representing an opportunity for smaller pension plans seeking to invest amounts as low as $5 million. While that figure is insufficient for smaller institutional investors to purchase property directly in many markets, it can give them access to dozens of properties through more liquid investment funds. The sale of directly held property may include a lag of six months or longer, but pooled investments may be sold more quickly. In a low interest rate environment, such liquid funds can provide greater capital appreciation and enable pension funds to boost investment returns and dampen overall portfolio volatility.

Crucial to institutional investing is a knowledgeable manager equipped with a robust real estate investment process. Successful real estate portfolio managers require both embedded local-market expertise and a global market footprint, providing confidence to pension plans seeking alpha.

Michael Peck (CFA, MBA) is senior vice-president, institutional investments at Invesco Canada Ltd.

*Source: Invesco Real Estate, as of December 31, 2016

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