This article is sponsored by Macquarie Capital Real Estate Advisors.
Over recent years PFA’s “global assault” has transformed it from a domestic core investor to a global player with $10.4 billion of real estate assets under management. The past 12 months have seen the Danish pension fund strike a diverse range of big deals around the world, including buying $1 billion of core German residential, taking a stake in the landmark Devonshire Square office scheme in the City of London and establishing a venture to develop logistics in China. Danish pension PFA’s head of real estate Michael Bruhn and Macquarie Capital Real Estate Investments’ head of EMEA private capital markets Zahar Mejanni discuss the strategies, headwinds and structures shaping the investor’s allocation to the sector.
Designing a global strategy
Michael Bruhn: You cannot just export a strategy that works for core investments in a small country like Denmark and expect it to work around the world. Examining global megatrends provides us with help and guidance as to what investments we should look at. In determining our strategy for 2018 we identified 10 megatrends: demographics, economics, consumption, technology, health, transportation, food, energy, environment and globalization, as well as a number of sub-trends within those areas that will impact real estate. We then cross-referenced that with an index of how rich and developed countries are. For instance, the aging population is a megatrend that is obvious in India, as well as in Europe, but doing serviced senior living is not really for India because the country is not developed enough for there to be the available wealth to do that kind of scheme. Once we have identified the megatrend and sub-trend that supports an asset class we look at the available opportunities across the risk classes we invest in. For instance, the value-add segment in logistics in China does not really exist. It is core or it is opportunistic. Either you have developed something and let it on a long lease, or you are developing it.
Zahar Mejanni: Structural tailwinds also underpin our investment strategy and play a large part in determining the sectors and geographies in which we invest and the specialist real estate managers that we partner with. Whether we are investing ourselves or advising select third-party clients, we look for opportunities that are supported by the adoption of new technology, rapid growth in e-commerce, urbanization and shifting demographics. We’re creating opportunities that benefit from these structural changes and outperform through cycles. That is why we particularly like the logistics and multifamily sectors and markets like Australia, which has strong population growth forecasts even when compared with emerging markets. The US is another example where population growth is relatively strong in comparison to other developed markets.
MB: One of the managers we work with divides strategies up into those that are driven by GDP growth and those driven by necessity – like medical offices, retirement living or student housing. With the latter, instead of the growth in the investment coming from factors like rental increases it comes from undersupply. If you look at mainland Europe where GDP growth is not very high maybe that is something you should have in mind: German residential could be seen as necessity driven because there is such a shortage of housing in the seven biggest German cities.
Meeting the challenges of a changing investment landscape
ZM: We are both strong believers in the long-term benefits to be gained from investing in the logistics and multifamily sectors. Globally, industrial sector activity continues to strengthen at the expense of retail. What is your view of the market sentiment on retail? Do you think the sell-off is an over-reaction or is it justified given the growth of e-commerce?
MB: We only have one relatively small shopping center investment in Denmark, but I have seen how much effort and investment it takes to adapt that asset to the trend for more experience and convenience-based shopping. Where you have flagship stores high-street retail is different, but I am still a little concerned about the long-term viability of those assets because even some of the biggest high-street retailers are having to reinvent themselves and that may mean they will occupy fewer city center stores. The pace of change in the sector is exponential. We could see as much change in the next two years as we have over the past 10, which is a little scary.
ZM: I think change also creates opportunities. As customer expectations evolve, more assets are shifting towards accommodating services or are linking themselves to e-commerce through click and collect or even becoming part of the last mile delivery network. It is not easy to implement and not for everyone, but in the last year or so we have seen a small uptick in retail transactions. Some experienced retail managers willing to ride the wave for the next few years will take advantage of opportunities to buy mispriced assets where they can drive value.
MB: My biggest concern is how we should react to the magnitude and speed of the technological changes that will impact real estate. Will tenants still want to occupy the current generation of logistics buildings when the next generation of robotics are designed and installed? With the developments in artificial intelligence, is a big office block with a 10-year lease to a prominent accounting firm or a bank a good bet, or will they make half their employees redundant in a few years? That is why I am comfortable with residential because people will always need a place to live. It is also one of the most important reasons why we bought a 45 percent stake in Devonshire Square in the City of London. Not only is it occupied by WeWork, but it is right next to Liverpool Street station with the new Crossrail link due to open soon. It has been there for the last 150 years and we think that asset will still be attractive in 100 years. In spite of Brexit, we are making that bet because we think it is an asset for the long haul.
ZM: People will continue to want to live, work and play in areas that are proven and being so close to a major transport hub should give you comfort for the long run especially with a strong existing tenant, because occupiers will always want to be in these locations.
Striking a balance between investors and managers
ZM: Over your career you have worked as both an investor and manager. How important is having seen things from the manager side been in your current role leading a pension fund’s allocation to real estate?
MB: If you want to have a long-term relationship there has to be a balance between what the investor is getting out of the mandate and what the manager is getting. We have managers that perform very well and provide strong returns, and of course we like to back them. The problem is the really good managers can attract a lot of capital and that makes the discussion when it comes to fees more difficult. The allocator model is the less preferred route for us, although sometimes it is the only way to get into an asset class and region. We like to do more direct investments because we like to have more control over decision-making and because of cost. If we go with a manager we definitely prefer club deals or joint venture structures that have a handful of investors so that more of the decision-making sits with the investors. If you are looking at an asset that sits slightly outside the strategy and you have to decide if you should buy it anyway, it is easier to do that if you are part of a small group of like-minded investors. In a big commingled fund it is much more difficult to maneuver.