Spotlight on indirect real estate investments
Swiss pension funds increasingly turn to indirect investments in international real estate. Andreas Dick, Portfolio Manager at the AFIAA Investment Foundation, talks about the advantages of multi-manager approaches and opportunities abroad.
Institutional real estate investors in Switzerland are facing stagnating rental income and declining initial returns. How attractive and sustainable are alternatives on the global real estate markets?
Today, many institutional investors can only expand their local real estate allocation via highly competitive bidding processes. Top returns are slipping well below two per cent in many places, which leads to a significantly higher risk and lags behind the portfolio returns. Taking a look at the bigger picture is definitely worth it.
Which advantages do you perceive in the bigger picture?
First and foremost, a number of international real estate markets offer geographical diversification and benefit from a low correlation between regions and countries. This ensures stable returns independent of real estate cycles and creates a solid foundation for a balanced portfolio. Diversification abroad should not be exclusively associated with producing higher returns than on the domestic market. In fact, from a considered risk management perspective, it should rather be associated with removing a certain amount of volatility from the investment portfolio.
Andreas Dick, Portfolio Manager and responsible for indirect real estate investments at the AFIAA Investment Foundation.
When it comes to pension funds’ real estate investments, the yield spread between risk-free government bonds and the current yield from rental income plays a central role. What does this spread look like?
Investors like to be compensated for their investment risks. As a result of the ongoing negative interest rate environment that has persisted since the financial crisis, the spread has widened substantially in Switzerland. This has made real estate investments all the more attractive. However, the supply is limited and cannot satisfy the growing demand. We know what this means: prices go up and returns go down. The interest rate on ten-year Swiss government bonds has been rising steadily since the beginning of the year, giving rise to the question whether the current risk premiums on Swiss real estate are still considered as attractive, especially where properties in peripheral locations are concerned.
What does the yield spread look like for investments in international real estate?
Yield spreads between the main international real estate markets and the respective 10-year government bonds suggest that risk premiums are very profitable in some markets, although the markets diverge considerably in this respect. These days, we are also seeing high market valuations for foreign properties, especially those in central locations in major economic hotspots.
“Non-listed funds allow for greater diversification across sectors, regions and fund managers.”
When investing abroad, is direct or indirect exposure the obvious choice?
There are various ways to build exposure in real estate investments. While there is no one “right approach”, there are different ways that cover different objectives. These ways can vary greatly from one investor to the next. Today, the majority of real estate investments are still held directly. While this approach offers a high degree of control, it also entails a cluster risk and relatively low liquidity.
What are the advantages of indirect investments?
Non-listed funds, which allow for greater diversification – across sectors, regions and fund managers – have been playing an increasingly important role in recent years. However, the effects of the impressively low or sometimes negative correlation between real estate and other asset classes can be achieved more efficiently via a multi-manager solution. As well as local expertise and a thorough grasp of the underlying economies, building a global real estate portfolio also requires an established local network that can provide access to attractive investment opportunities.
How specifically do you implement diversification?
Our AFIAA Diversified indirect portfolio, which focuses on indirect investments, pursues diversification not only across different countries and property cycles but also, and particularly, through differentiation according to types of use. In this respect, we continue to benefit from the trend away from bricks-and-mortar retail towards e-commerce, where we anticipate long-term demand for suitable logistics centres and micro distribution facilities in the future. We also see opportunities in new economy sectors, for instance self-storage, life sciences, student housing and the US medical office sector.
“The healthcare sector in the US hat stood out for its strong performance for several years now.”
What is interesting about the US medical office sector?
This industry benefits from long-term structural trends, such as an ageing population and a shift in patient care. Healthcare is still the largest industrial sector in the US, accounting for nearly 20% of GDP. For several years now, the sector has stood out for its strong performance in terms of rent growth, low vacancy rates and high tenant loyalty. The general trend on the US healthcare market is shifting from an inpatient focus to a more cost-effective and convenient outpatient model. This transition has been accelerated by the pandemic. Technology has also contributed to the shift, allowing services that were previously restricted to hospitals to be performed in outpatient buildings.
We often hear that the currency risk is an obstacle to international investments. How can this be addressed?
Similar to other asset classes that invest at the international level, global real estate investments also require investors to pay particular attention to currency risk. If you want to benefit from the total return effectively generated by your investment, it is advisable to hedge the currencies either at the level of the investment vehicle or at the level of the overall portfolio. When choosing an investment vehicle, it is therefore important to ensure that the respective share classes are hedged against the Swiss franc. Failure to do so may result in a dilution of the performance at the real estate investment level in the event of unfavourable currency developments.
What other aspects have to be taken into account when choosing an investment vehicle?
A Swiss investment foundation offers Swiss employee benefits institutions two advantages: the investors represent the same interests and the foundation is a tried-and-tested investment structure under Swiss law. When choosing the investment vehicle, it is important to ensure that its tax structure is advantageous for Swiss pension funds. In this respect, Swiss investment foundations representing Swiss pension funds also act as so-called “filing blockers”. This means that the pension funds are not subject to individual reporting and tax declaration requirements by the respective tax authorities in the target fund country. Instead, such requirements, if any, are fulfilled by the investment foundation. Another driver of success is a well-established multi-manager approach to selecting the underlying target funds that is based on the best-in-class principle.
Are you interested in international real estate investments?
We offer Swiss pension funds both direct and indirect international real estate investments. For direct investments, choose the AFIAA Global investment group; for indirect investments, choose the AFIAA Diversified indirect investment group.
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