The institutional investor opportunity in real estate and other alternative assets
By Nick Edwards, COO, Audley Group – A couple of weeks ago global advisory company, Willis Towers Watson, published research into the size of the global pensions market. One of the lead findings being that the UK pensions market has been overtaken by Japan, pushing the UK into third place, with both sitting behind the United States which holds a significant share of the market – 62 per cent of worldwide pension assets.
But digging into the detail of where these pension assets are held is where it gets interesting for me. Among the seven largest pension markets – Australia, Canada, Japan, the Netherlands, Switzerland, the UK and the US – the UK has the smallest allocation to alternative assets such as real estate. Just 8 per cent versus the average of 26 per cent across these markets.
Why is the UK trailing behind on alternatives?
At the start of 2019 the All-Party Parliamentary Group (APPG) on Alternative Investment Management looked into the lack of alternative investments held by pension companies in the UK. They found that a series of cultural, regulatory and operational pressures encourage pension companies to shy away from investing in alternatives.
The story is slightly different for defined benefit (DB) schemes and defined contribution (DC) schemes.
DB schemes have already expanded beyond the traditional options available and into alternatives. But DC schemes, which are growing rapidly as a proportion of total pension assets in the UK, haven’t undergone the same change. As the APPG report showed, there are a few reasons why.
DC schemes are held by a tighter level of regulation and this is especially true for money which sits in default funds. Strict charge caps introduced by the FCA, occupational scheme regulation and limits on the assets they can hold in certain schemes see DC schemes largely invest into equities, bonds or cash.
On top of this, DC schemes typically buy investments that are highly liquid, and they can trade out of on any given day. Not a regulatory pressure, just something that is now seen as the norm and aligns with expectations.
In combination, these factors mean that a very small proportion of UK DC pension capital is held in assets other than equities, bonds, or cash.
Why is this an issue?
At its very simplest, it is a missed opportunity. But really it is rather more than that, as arguably it artificially increases the cost of capital for alternative assets, who turn to private equity funds with their higher return aspirations for their funding.
And there are societal factors to consider here as well. I won’t be the first, or the last person to tell you that the UK population is ageing. In 50 years’ time, there is projected to be an additional 8.2 million people aged 65 years and over in the UK – a population roughly the size of present-day London.
This, mapped against the working population, puts huge financial pressure on the whole pension system. And that is without the economic pressure of the pandemic or the lower returns expected from traditional assets like bonds in the coming years.
The concern is that this will change the way we all retire and not in a good way. We will all face decisions like continuing to work on later in life, retiring with less money, or upping our contributions now to safeguard our financial future.
As we are all making our own financial decisions, there needs to be acknowledgement that change is also needed in the way that large pension companies invest, away from traditional investments and into alternative assets with different return and liquidity profiles. And whilst historically, it has been hard to win over large institutional investors, I think the tide is starting to turn.
Last year we announced a new joint venture with the Royal London Pension Property Fund to fund a new £80million retirement village in Berkshire. An alternative real estate investment for Royal London. This is Royal London’s first move into the housing with care market but not the first from an institutional investor. We’ve undertaken a £400m multi-site joint venture with Schroders Real Estate in a fund managed by Octopus Real Estate and Audley Group’s largest shareholder is PFA, the Danish Pension Fund. L&G also has a retirement village arm and AXA Investment Managers own the Retirement Villages Group.
The moves into the retirement living market which have taken place in the last few years are recognition of the potential of the market. From a real estate perspective, that recognition has significantly increased over the last twelve months as the more traditional real estate investments in offices and retail have hit the buffers, and the impact of COVID has heightened awareness of the challenges in the economic provision of care.
It’s imperative that pension funds are investing in companies which deliver a positive social impact and have a strong culture of ESG. Since 2019 there have been legal and regulatory requirements for trustee boards, pension providers and asset managers to consider ESG factors when making investment decisions, which paves the way for fundamental change in this area. It isn’t enough to focus on quarterly or annual profits – management teams now have to place those objectives in a wider social context.
This is excellent news for the retirement living sector, because central to the mission is to help people live better for longer and there are significant social impact benefits from providing supported living for wider society. Ones which have been historically under-valued or perhaps even misunderstood. Many of the issues faced in our social care system result from people living in unsuitable housing, particularly as they age, and this places intolerable pressure on the NHS and social care systems. Housing with care solves this challenge, frees up much needed family housing and provides the balance of an independent lifestyle with an emphasis on health and wellbeing, and care support as it is needed. Not only this, but investing into this market aligns pension funds with the providers of their capital.
The outlook is positive for the retirement living sector. In its Senior Living Review 2020, Knight Frank noted that institutional investment in this sector was expected to exceed £1.5bn in 2020, a record year. All while the market penetration remains low in comparison to international counterparts. Retirement living properties account for just 1 per cent of the market in the UK, compared with 5 or 6 per cent in the Australian, New Zealand and US markets.
The sector is anticipated to continue its current growth trajectory, maintaining a rate of 10 per cent per annum over the next five years. This will take the total housing stock to more than 800,000 by 2024. I think growth will be materially faster than this, but, even at this level, there should be investment opportunities – provided the investor can find right the right partner to work with.
And, this is where the retirement living market presents a big opportunity for institutional investors. As pension funds see the need to diversify, to move into alternative assets whilst safeguarding returns, the space is ready for growth and provides funding models which deliver a secure, inflationary linked, long-term income stream. At the moment, those income streams deliver a high yield on cost, but not because of the risk.
The last couple of years are just the start of things to come and we will see the UK’s allocation to alternatives grow, and a large part of that will be real estate and more specifically retirement living. And those super secure, high yielding income streams will have been missed by those that don’t consider alternatives.
2 APPG – Alternative Investment Management: UK Pension Schemes and Alternative Investments
3 ONS population estimates - https://www.ons.gov.uk/peoplepopulationandcommunity/populationandmigrat…;
4 Knight Frank Senior Living Annual Review 2020 - https://content.knightfrank.com/research/1854/documents/en/senior-livin…;