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Re/insurers have said that real estate and property markets remain their go-to in times of macroeconomic volatility, as the asset class is a vital inflation hedge, or safe haven.
However, the full picture may be more complex – with rising interest rates, vacant commercial lots, and bankruptcies making things less rosy than in previous years.
But global re/insurers – particularly those in the UK and EU – aren’t backing off just yet.
A recent example of a substantial institutional investment in the real estate market comes from Pension Insurance Corporation (PIC), the specialist insurer of defined benefit pension funds, which recently funded the construction of 500 sustainable waterfront apartments in the UK.
"The real estate sector is grappling with the impacts stemming from a high inflationary [and] high interest rate environment that we find ourselves in."
The development cost £130 million and “includes 100 affordable homes”, said a release. It added that, “once complete, the cashflows from [the development] will help to pay the pensions of PIC’s policyholders over the next 50 years.”
Jose Pellicer, Head of Strategy at M&G Real Estate, said he felt the real estate sector had taken recent hits, largely due to the impact of inflationary conditions and an extreme rate environment.
“Like every asset class, the real estate sector is grappling with the impacts stemming from a high inflationary [and] high interest rate environment that we find ourselves in, such as rising construction costs for assets which are being upgraded to achieve better ESG credentials,” he said.
Construction costs and ESG concerns were seen as a causing a headache for the asset class, but not permanently. It’s true that in difficult market conditions, real estate has been viewed as a traditional hedge against inflation, said Pellicer.
“Property offers income growth, which, in cases can be close to inflation over the medium term,” he said – adding that this is particularly the case for long lease investments where a fund’s income is linked to inflation annually.
However, Pellicer was quick to add that while real estate looks attractive right now, it is “not a perfect hedge” and should only be considered if the specific property looks right. This was because there were difficult-to-predict variables that factored into the equation – such as tricky tenancies, bankruptcies, and rent negotiations.
“Historically over the medium term, income growth that real estate has enjoyed over a five-to- ten-year period has been mildly correlated to inflation."
“Historically over the medium term, income growth that real estate has enjoyed over a five-to-ten-year period has been mildly correlated to inflation, but of course, many assets don’t enjoy income growth”, he said. “The tenant can leave, go bankrupt, or just renegotiate a rent at a lower level because they have other potential buildings to go to.”
Pellicer noted that there was also the lingering possibility that higher interest rates would put downward pressure on values. Ultimately, he eschewed heuristics for something more like a cautious optimism, preferring to assess opportunities individually and thoroughly.
Some of Pellicer’s concerns have been backed up. Across other areas in the EU, factors such as interest rates remaining higher for longer than expected alongside a significant pool of real estate-related debt falling due over the next couple of years have led to pressure on a sector. “[It] has been among the worst performing in the Stoxx600 so far this year,” said Lucas Maruri, Equity Portfolio Manager at MAPFRE AM, part of MAPFRE.
ESG considerations are also at the top of insurance investment teams lists of worries – with solutions hopefully on the horizon.
Earlier this month, a working group comprised of Association of Real Estate Funds (AREF), the European Association for Investors in Non-Listed Real Estate (INREV), and the Investment Property Forum (IPF) published an Sustainable Finance Disclosure Regulation (SFDR) Real Estate Solutions Paper that discussed the challenges that were arising from the SFDR framework for real estate investments.
“Owners and managers must focus on sustainability and finding solutions in management and investment to keep pace with market dynamics.”
The paper proposed numerous potential remedies to specific challenges posed by the SFDR regime, including: 1) differences in the calculation methodologies between the TCFD’s recommendations and the SFDR, 2) inconsistencies with energy performance certificate (EPC) ratings among EEA member states, 3) confusion surrounding what should be included under the mandatory PAI “exposure to fossil fuels”, 4) treatment of energy inefficient assets under the PAI.
Meanwhile, a recent analysis from Schroder’s said that in order to secure its longevity – and place in an institutional investor’s portfolio – the asset class was in dire need of futureproofing. “Owners and managers must focus on sustainability, operational excellence, and finding new solutions in management and investment to keep pace with changing market dynamics,” the report noted.
It added that investment performance, even outperformance, didn’t have to be out of sync with sustainability and due diligence. The key to achieving these results, it said, was considering different structured solutions that could best cater to governance preferences. Factors to consider included the duration of the investment opportunity, liquidity needs, and its market cycles and timing fit with the investment strategy.
It added that investments “seeking to benefit from a short-term supply/demand disruption, or a ‘fix/sell’, are typically better governed directly or in a short-term, closed-end structure.” However, on the other hand, “investments seeking to benefit from long-term structural trends are best accessed with low-cost, longer-term capital structures or partnerships.”
This means that insurance investment teams will need to do their homework and be especially choosy when considering the sustainability of their real estate investments. The report added that another consideration was relative and risk-adjusted value, as embedded in the explicit price of various structures.
Real opportunities in this asset class were less straight-forward than many expected, with a careful combination of direct investments and investments in open-end funds, closed-ended partnerships, listed funds, and/or real estate loans.
Diversification within the asset class was encouraged to boost exposure and mitigate risk; “optimising and mixing various investment structures opens up the entire universe of the real estate investment market,” the analysis said. “[It] allows for optimal access to operational excellence.”
Hans Vrensen, Head of Research and Strategy Europe at the global real estate asset manager AEW, said that the outlook for European real estate specifically had benefitted from a recently-improved macroeconomic backdrop.
“In our latest base case,” he said, “a European-wide recession is avoided in 2023. Also, lower inflation expectations have become embedded in both actual and projected government bond yields.”
These predictions match those for the United Kingdom from the International Monetary Fund (IMF), which recently said it expected the UK economy to miss a full recession, despite inflation remaining stubbornly high.
In its April 2023 “World Economic Outlook” report, the IMF said it saw two main mechanisms at work contributing to these conditions. The first was that high-growth emerging markets were providing alternative investment opportunities – which meant additional capital outflows at higher rates in developed economies.
The second factor was that fact that the supply of safe and liquid assets – typically considered to be US government bonds – were not keeping pace with rising demand, especially from emerging markets. As a result, there was a scarcity of ‘safe’ assets, which the report said was driving prices higher whilst lowering returns.
“Our analysis shows that investors should benefit from a projected rebound in capital values and total returns across the majority of European markets."
Another consideration, Vrensen said, was that changing conditions hadn’t completely mitigated downside risk. “Our latest forecasts confirm that there is still some remaining downside in capital values for most European markets during 2023,” he continued.
Nevertheless, the future of the asset class is looking up, and Vrensen echoed positive sentiment around additional allocation in 2024 and beyond. “Post 2024, our analysis of the market shows that investors should benefit from a projected rebound in capital values and total returns across the majority of European markets,” he said.
It was important to note, he added, that risk averse insurers with more immediate allocation requirements – often those with less predictable, non-life liabilities – would see new benefits as markets recovered and the asset class retained its shine.
“[They] should be able to find attractively priced risk-adjusted return opportunities in private real estate debt,” he said, attributing this change to the many upcoming re-financings of 2018-20 vintage low interest loans that required additional capital commitments priced at higher current interest rates.
The market, whilst long-considered a safe haven, still requires additional consideration, particularly revolving around ESG issues that might seem less significant now but will be make-or-break in years to come.
Diversification within the asset class is necessary, and market volatility is still taking its toll.
