“It is possible to generate sustainable returns in core markets without taking on more risk”

In 2020, AFIAA Investment Foundation acquired its first property in Sweden. Sebastian Feix, Head of Transactions International, talked to us about the reasons behind this market entry.

AFIAA recently made an investment in Stockholm. What are the factors that drove this decision?

With Stockholm being one of the most attractive real estate markets in Europe, based on our internal analysis, we have had an eye on the city for some time now. Demand on the office market is high and supply is limited, so prospects for long-term rent growth are good. 75 percent of the Stockholm real estate market, especially the centre of town, is dominated by local investors, making it difficult for foreign operators to enter the Swedish market. During the global corona pandemic, when many competitors had not yet resumed market activities, we took advantage of a rare opportunity to invest in Stockholm.

The office building is fully rented to a single tenant. Does this entail a cluster risk?

Given the property size and the rent volume, we believe there is no cluster risk at the portfolio level since the tenant barely makes it among the top 30. On the contrary, aside from contributing to our sector diversification, the tenant also has an excellent credit rating and plans to use the building on a long-term basis.

Institutional investors are complaining that it is getting more and more difficult to find suitable properties in Switzerland. Would it be worth their while to look beyond the national borders?

Absolutely. Although international returns have been getting close to Swiss levels in the last few years, investments abroad make a positive contribution to diversification – which is a crucial factor for our investors. In core markets, such as Stockholm or Munich, it is possible to generate sustainable returns without taking on more risk. On top of this, in markets like Lisbon or London, returns are higher than in Switzerland. And with different currency areas increasingly being incorporated into products via hedging strategies, there are now enough products for Swiss pension funds to choose from.

Which markets are relevant in this context?

For our directly investing AFIAA Global portfolio, we have currently identified 27 cities worldwide as potential investment locations. Aside from real estate-specific aspects, such as market size and vacancy rates, we have also analysed the general city profile and its development, including factors such as infrastructure, GDP contribution, population growth, technological innovation and business variety.

In European comparison, real estate investment valuations in Switzerland are high. Initial net returns on prime office properties are over 1% lower than comparative returns abroad, for instance in the UK, Sweden or Germany. Does this affect your investment decisions?

Prospective returns are certainly a crucial driver of our investment decisions. It is essential to thoroughly analyse the specific risk that is associated with an investment and whether the expected return will provide sufficient compensation. We are fundamentally pursuing a conservative investment strategy. Per se, international investments do not involve higher risks than investments in Switzerland, nor do international markets always outperform local investments.

Swiss pension funds aiming to minimise risks should diversify their investments.

 

International investments are of a complex nature and require solid partners in the target markets. How do you select suitable local partners?

Both our transaction team and our asset management team are active in our target markets Europe, North America and Australia and maintain close contact with a large network of market participants, tenants and service providers. We are pursuing a long-term investment strategy and prefer long-term relationships with our business partners. Maintaining these relationships is therefore a priority for us.

Active portfolio management is thus important at the international level. Do simple buy-and-hold strategies make less sense?

There is no simple answer to this, it is not a black and white issue. We know many investors who buy into club deals or long-term sale-and-leaseback transactions as part of their passive investment strategy. However, this involves a different extent of financial engineering and respective risk, which must be analysed. Our strategies focus on the property and its return components. This requires active management. Given this background, the expression “buy and manage” would be a better description of our management approach.

On average, Swiss pension funds invest no more than 2.4 percent in international real estate, while domestic real estate investments account for an impressive 21.8 percent. Should Swiss investors be greater risk takers in this area?

Looking at the Swiss real estate market and its 20-year rise, this trend is not surprising. For many market participants, the question simply did not arise. However, Swiss pension funds aiming to minimise risks should diversify their investments. In this respect, adding international real estate to the portfolio can be a sensible option. The high investments that were often required to develop viable portfolios used to impede expansion into international markets, allowing only large-scale investors to take this step on their own and build up the necessary know-how. A lot has changed in the last few years and the market has advanced, especially on the product side. On top of this, as a result of progressive consolidation in the pension fund world and the associated growth in assets, real estate allocations for international products are now being included in ALM studies.

Despite the benefits of diversification, the number of Swiss investment vehicles offering international real estate is still small. What is the reason for this?

The fact that AFIAA Investment Foundation was established in 2004 makes it a pioneer in the field. Today, there is growing competition on the market. On the other hand, in times of low returns, investors concentrate increasingly on costs and TERs. As yet, few pension funds are considering international real estate for their portfolios. Investors who do opt for this asset class therefore prefer existing, larger investment vehicles over newer, smaller ones. As a consequence, it is mainly the larger, established providers that are expanding, while so-called first-time funds are finding it difficult to attract sufficient seed capital. Even if international real estate allocations were to expand in the future, it may be only the managers with specific know-how that have the structures required to implement specific investment concepts.