The research team were commissioned to examine the evolution of the UK institutional real estate funds industry in the 10-years post the Global Financial Crisis (GFC) and then consider what is likely to happen to the industry for the next 10 years (post COVID-19). The project findings have been split into two reports. The quantitative analysis of fund data for the period since the GFC forming the entirety of this report with the forward looking, qualitative piece due to being published later in 2021. This report attempts to cover the central themes of fund investment: the universe; performance; stock selection; liquidity and fees and how these have evolved over the last 10 years. The analysis was conducted on the data in the MSCI/AREF Property Fund Vision (PFV) Handbook and for certain tasks, especially performance analysis, the team also relied on data from the MSCI/AREF Property Funds Index1 (The Index).
It is estimated that the funds in the PFV Handbook cover 13.5% of the GAV of all UK real estate institutional investment, this is an increase from 9.0% since the GFC. The success of some Specialist funds and the growth in Long Income funds has offset the lack of new funds joining the AREF sample.
The UK real estate fund industry, as reported by the PFV Handbook, provides a range of fund types and sizes to accommodate most investors, but not the scale required for the very largest global investors. Conversely the minimum investment rules in many funds set a relatively high hurdle for initial investment for smaller investors.
There have been two long upswings in real estate returns over the last two decades punctuated by a significant reversal triggered by wider macro-economic events in the GFC. Over the last 10-years All funds have delivered a 6.1% pa return, higher than equities, bonds, and property equities at 4.1% pa, 4.5% pa and 5.6% pa respectively. The strongest returns have been generated by Long Income funds, although this performance track record spans a relatively short time period.
Specialist funds have delivered two periods of relatively weak returns, the first during the GFC which was exacerbated by high leverage and the second in the period since the GFC due to the high weighting to large retail property types. Individual, low-geared specialist funds, outside the retail sector, performed much more strongly.
From q3 2004 to q3 2020, cash is estimated to have reduced All fund returns by 14 bps pa and Balanced fund returns by 23 bps pa. Debt is estimated to have reduced returns by 48 bps pa. Since the GFC the stock of debt has shrunk from over £12bn to less than £4bn.
Portfolio performance has been driven predominantly by structure. In the latest cycle the rise of e-commerce has driven both weak performance from sections of the retail sector, particularly shopping centres and retail warehouses that formed the bulk of Specialist funds, and strong performance from industrial property.
The Balanced fund allocation to retail has now fallen to 20%. Due in equal measure to relative sector performance and by a reallocation to predominantly industrial property.
Long Income funds are an exception, they have performed differently, either due to their very long lease structures or due to the selection of different property types within the enigmatically labelled ‘other’ segment. Other fund styles may be significant, such as a focus on high, or low, quality property but no quality measures are included in the PFV Handbook.
The combination of leverage, cash, structure, development exposure and net investment flows explains nearly two-thirds of the variation in fund returns over the period 2007-19. After splitting the model by fund type, the explanatory power of the fund return model rises to 80% for both Balanced and Specialist funds for the whole time period and higher for the sub-periods. The combination of leverage, cash, structure, development exposure and net investment flows explains over three-quarters of the variation in individual fund risk-adjusted returns. A focus on a smaller number of properties is not found to have generated superior risk-adjusted returns. Leverage across both aggregations has had a negative impact on either, or both, excess and risk-adjusted returns. Cash and net investment were significant drivers of both Balanced and Specialist fund returns through the GFC. In the case of Balanced funds, there is evidence that liquidity management adversely affected fund returns through this period and for Specialist funds the higher the cash holdings and the more positive the fund investment flows, the stronger the fund returns.
Diversification, through more properties or tenants, is found to significantly reduce tracking error. A higher development exposure increased the tracking error of funds against their predicted return in several of the models, but the measure was not universally significant. This result cannot be regarded as definitive due to the low exposure of the analysed funds to development.
Other measures, such as WALT, initial yield and vacancy rate, are rarely significant in models of fund risk, but this lack of a positive relationship is thought to be due to the recording of these factors at the portfolio rather than the segment level.
On average, the net units created in funds averaged 1.8% per quarter and turnover 5.1%. Daily priced funds have experienced far greater redemption pressures during periods of market distress, peaking at 15% in q3 2016.
A small group of Balanced funds offered significantly superior liquidity, via matched transactions, at over 1% of units per quarter. These funds tended to have a less concentrated investor base.
The top five investors typically held around 50% of units in institutional funds. For daily priced funds, currently around 30% of fund units are held by the five largest investors. There may be issues over how feeder funds and/or platforms are counted meaning that investor concentration might be lower on a look through basis.
The proportion of external capital within funds increased steadily from 2004 to 2011 and since then it has remained broadly in the 65-70% range.
There is evidence of a small shift to NAV pricing, with the reported fee basis for 65% of funds in 2007 falling to 51% of funds by 2019.
_____________ 1 Please note that the sample of funds in the PFV Handbook is slighter higher than that contributing to the AREF/MSCI Property Funds Index.
