Feature – Property
and take-up over secondary space as corporates seek more effi- cient space in line with their net-zero commitments and in a drive to attract and retain talent.”
Safe as houses Christophe Montcerisier, head of real estate debt at BNP Paribas Asset Management, offers what he says are “compel- ling reasons” for considering an allocation to commercial real estate debt ahead of other opportunities.
The first is that commercial real estate debt funds offer indirect inflation-linked income streams typically 100-160 basis points higher than public-market debt with a similar credit worthi- ness: an obvious attraction in these inflationary times. “The span of a commercial real estate debt fund investment is typi- cally 10 years, which suits long-term investors such as pension funds,” he says. Here he asserts that rising interest rates are not a danger, as loans are set and adjusted in line with changes to the base rate. “As with other mortgage-type products, there is a 0% floor on interest payable, which means that negative yields are not pos- sible. Negative yields are a reality for a lot of publicly traded paper so we can say there is extra value these days in the illi- quidity premium,” he says. In addition, he adds: “Commercial real estate debt is fully col- lateralised. That is one strength of investing in bricks and mor- tar. Senior debt holders have first-ranking mortgages.” Montcerisier says loan-to-value ratios have been falling, provid- ing, he suggests, another source of comfort, because it means the equity borrower has more “skin in the game”. Finally, there is diversification by ultimate revenue. “It is com-
mon for funds to have exposure to more than 2,000 tenants, situated in hundreds of properties in different jurisdictions,” he says. “Investors can take comfort that their income – typically distributed quarterly – comes from a greater variety of underly- ing sources than many other forms of debt,” Montcerisier adds. Setting out the Oxford Economics view, real estate economics associate director Christopher Babatope offers some advice on how investors may need to modify their approach. “In the near term, property investors will likely need to shift their focus towards assets with solid levels of rental uplift potential and income growth,” he says. “The past few years have seen total returns largely driven by elevated levels of capital appreciation, driven by yield compression.”
Property outperformance
A lot of environmental and social benefits can be achieved from property in a way that’s clearly aligned with generating attractive
investment returns. Doug Clark, BT Pension Scheme
Babatope believes that in most instances, yields are likely to soften over the near term – as the cost of capital rises and aver- age credit spreads increase. “This will create additional near- term uncertainty for commercial real estate performance. “That said, our five-year forecast for commercial real estate sees all-property direct returns outpacing those of bonds, real estate investment trusts and wider equities market.” Babatope adds that while near-term uncertainty will impact all sectors, “occupier fundamentals” for growth segments, for example, urban industrial assets and residential, remain posi- tive. “Broadly speaking, focusing your attention on selective assets within these sectors, and diverting your attention away from sectors facing structural headwinds – traditional offices and retail – will help to produce stronger returns,” he says. This represents Oxford Economics view at the national level and there are nuances. “While the office sector appears weak from a top-level perspective, flight-to-quality trends mean prime, new developments in core sub-markets continue to per- form well,” Babatope says. Looking ahead, he adds: “With a deteriorating economic out- look and rapid monetary policy tightening likely to continue over the near term, we expect that the speed of execution of lending and overall transaction levels will remain slower and lower than in recent history.
“The buy-sell spread will likely remain wide and volatile over the coming quarters, but we firmly believe there are still posi- tive market transactions that can be made within commercial real estate,” Babatope says.
Attractive opportunities
There are a number of reasons why property is attractive for pension funds, as highlighted by Doug Clark at BTPS, who reveals the importance of property in the fund’s portfolio, which represents just under 10% of its assets. “From a strategic perspective, the income profile, inflation-
48 | portfolio institutional | October 2022 | Issue 117
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