Invest simply – and with good diversification

Real estate is an attractive component of a broadly diversified investment strategy. It has stable risk/return characteristics and a low correlation to other asset classes. Multi-manager products with unlisted investment vehicles based on net asset value (NAV) offer investors access to a global real estate portfolio with a single investment.

For several years, institutional investors have been facing a new situation on investment markets: Yields on bonds issued in industrialized countries are at historic lows – and they will likely remain there for some time if all indications are to be believed. A shift to equities does not seem sensible in many cases. In the search for alternatives, indirect and broadly diversified real estate investments are an option. They have relatively low volatility, a low correlation to other asset classes and attractive risk-adjusted yields. Previously, the choice was between direct real estate investments and a few exchange-listed collective investments or REITs. Direct investments do not provide an adequate amount of diversification, never mind an expansion into international markets. The problem with a lack of diversification could be solved with exchange-listed investments, but at the price of relatively high volatility, especially in the case of international real estate companies and REITs. In addition, these vehicles are also typically traded at a premium or a discount to the net asset value.

Quickly developing markets

A lot has happened over the last several years. Credit Suisse Asset Management, which specializes in indirect national and international real estate investments, has played a pioneering role over the last 14 years in successfully building up the indirect real estate segment. This proved to be a truly timely offering. As a result of the demand for reliable and stable alternatives to traditional investments and also because of the growing supply, institutional investors in Switzerland, particularly pension funds, have steadily increased their allocation to the foreign real estate segment of late. However, the share of foreign real estate investments held by institutional investors is still very low compared to such investors in other countries (the share for pension funds is less than 10% of the overall real estate allocation of around 24%, according to the Credit Suisse Swiss Pension Fund Index as of the second quarter of 2019). This is all the more surprising, as the share of Swiss real estate investments, at more than 20% of the total assets of Swiss pension funds, is very high. So, there is clearly a certain affinity for real estate investments.

Real estate as a share of the assets of Swiss pension funds

Real estate as a share of the assets of Swiss pension funds

Source: Credit Suisse Pension Fund Monitor

Foreign real estate, indirect 1.01% 0.92% 0.92% 1.29% 1.22% 1.30% 1.77% 2.19%
Foreign real estate, direct 0.33% 0.15% 0.16% 0.17% 0.16% 0.19% 0.11% 0.07%
Swiss real estate, indirect 11.85% 11.87% 12.00% 12.19% 12.28% 12.94% 12.89% 12.73%
Swiss real estate, direct 9.63% 9.09% 9.33% 9.19% 9.17% 9.31% 8.74% 8.59%
Total 22.82% 22.03% 22.41% 22.84% 22.83% 23.74% 23.51% 23.58%

An expansion into foreign real estate would broaden the investment universe, increasing both the yield potential and the diversification options. Real estate investments are subject to long-term trends driven by broad economic, demographic, and technological developments. For example, logistics properties are currently benefiting substantially from the ongoing shift in retail sales to e-commerce. Online retailers like Amazon and Zalando need about three times the logistics space as traditional retailers, and these traditional retail formats are under pressure. Around the world, the residential apartment sector in urban regions is on the upswing, as more people are looking for affordable housing in metropolitan areas due to the increasing appeal of city living. Several sectors, such as student apartments and medical offices (office space for medical practices and outpatient clinics), are benefiting from the rising number of students and demographic change.

These trends have been developing differently depending on the region. For example, investments in and rentals of multi-family houses are relatively heavily regulated in many markets. The supply of new buildings in the various subcategories – such as urban residential towers compared to low-rise multi-family houses in metropolitan locations – varies, and there is no equally strong demand from tenants for all rental classes. Such details matter with respect to logistics properties as well: Key factors include a modern construction standard, size and, of course, location. Managers with local roots are better able to take such trends and nuances into account. This allows them to choose the best local partners and funds from a global investment universe.

So, those who expand their horizons to an international level will benefit. Gaining access to the above-mentioned multi-manager products provides further decisive advantages. With this type of solution investors can achieve a broad, diversified exposure via a single investment. The portfolios are compiled by experienced experts who are able to take advantage of their knowledge of the local markets. Investors are also relieved of the need to manage the properties, which can be both time-consuming and costly. If the solution is not exchange-listed, there are no price fluctuations or premiums and discounts, as is standard in trading. It is true, however, that these investments can be somewhat less liquid than exchange-traded securities (most open, non-listed funds offer liquidity on a quarterly basis). On the other hand, multi-manager real estate funds have much lower volatility and a lower correlation to other asset classes than exchange-listed real estate investments.

The right solution

Certain multi-manager products can use a broad range of possible investment structures. For example, they can subscribe funds (primaries) and acquire fund units from other investors (secondaries), but investments in so-called club deals can also provide added value. In each case a very small number of investors invest in a modest real estate portfolio. Such opportunities are generally not widely marketed, so having a good network is essential. Furthermore, multi-manager products can also enable the acquisition of a real estate portfolio via a local partner (fund), i.e. it can seed a new investment vehicle. Another option involves co-investments, i.e. investments in a fund’s individual properties. Co-investments are attractive because of their fee structure and they offer the additional advantage of investing capital in a short amount of time, which may be attractive in a time of negative interest rates.

Dual role

Non-listed foreign real estate funds can play an interesting dual role in the portfolios of institutional investors. First, they boost diversification because of their low correlation to equity and bond investments as well as Swiss real estate, thus stabilizing the portfolio. Second, the modest level of new construction since the global financial crisis and continued growth prospects in many real estate markets around the world have led to attractive yield opportunities. The key factors are the selection of funds and the fund manager, who must have local know-how and experience in the relevant markets. Real estate markets are often characterized by local circumstances that are not easy for outsiders to understand. It is therefore advisable to rely on multi-manager solutions that offer local expertise as well.

Reasons to invest in non-listed real estate funds

Reasons to invest in non-listed real estate funds

The main reasons for investors to invest in non-listed real estate are access to expert management followed by diversification benefits for an existing multi-asset portfolio and by intentional diversification for an existing domestic portfolio.

For funds of funds, access to expert management and access to specific sectors are ranked joint first, followed by diversification benefits (both for a multi-asset portfolio and internationally) and stable income returns are joint second.

Source: INREV, based on a sample of 77 respondents

Multi-manager funds can represent an interesting option for investors, depending on an investor’s individual situation in terms of investment volumes, liquidity needs, and the costs of the investment solution.

Potential risks:

  • Performance risks: unexpected developments on the interest rate and currency markets may have a negative impact on the funds’ returns.
  • General investment risk: the products do not offer any guarantee of capital protection.
  • Economic risk: unexpected economic developments may have an impact on market prices and valuations.