The Appeal of UK Core Long-Income Commercial Real Estate Investing
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JULY 2021
The Appeal of UK
Core Long-Income
Commercial Real
Estate Investing:
An Attractive Alternative to
Traditional Liability Matching
The UK investor has few choices to deliver income that can meet their long-term needs. Despite having
less liquidity, private markets, and more specifically real estate, might be the best answer.
Defined Benefit (“DB”) Pension Schemes in the UK have to what is becoming one of the defining problems of our time?
traditionally sought to generate required levels of investment One answer is via a well-structured, well-executed long-income
return via investing across a balanced strategy, including strategy, enabling schemes to achieve stable and dependable
conventional liquid investments such as bonds and equities, index-linked liability matching over periods of 20+ years, whilst
together with more illiquid alternative assets such as real estate, also providing longer term distributable income returns of up
private equity and infrastructure. As DB schemes move towards to 4.0% per annum1. At a period in the cycle where comparable
maturity, the need to de-risk typically skews investment portfolios duration gilts provide approximately 1%2, this can offer real
towards the security and certainty of fixed income. At the same appeal and a welcome boost to scheme returns.
time, reducing inflows increase trustee focus on liquidity. The key to such ‘bond proxy’ investing is to execute within
Asset value deflation, initially post-Global Financial Crisis clearly defined risk parameters, ensuring that income streams
(“GFC”) and more recently due to the global Coronavirus are long in duration, secure in nature and progressive via
pandemic, has led to extended periods of Quantitative Easing inflation linked indexation. Core long-income investing into UK
and a flight to safety and defensive investing. This has pushed real estate can achieve all of these things if deployed within a
bond yields to historic lows and large numbers of mature DB strategy that targets secure income and strong terminal residual
schemes into deficit; a dynamic that has been exacerbated by land values. Furthermore, with returns generated via a series of
an ageing population across major western economies, with DB direct asset ownerships, the ability to acquire and manage within
schemes required to support more retirees for longer. This so- a sustainable framework can ensure responsible ESG investing.
called pension ‘timebomb’ is starting to tick loudly for a number This paper explores the case for investing into UK core long-
of mature DB schemes. income real estate as part of a balanced investment strategy for
So, how can UK commercial real estate provide a solution mature DB pension schemes.
1 Fiera Real Estate UK as at 30th June 2021 2 Bloomberg, July 2021
–1–
Definition of Long-Income UK Commercial Real Estate and
Commercial Real Estate the Appeal of Long-Income
Long-income commercial real estate in the UK market describes Real Estate in the Context of UK DB Schemes
commercial property with leases of at least 10 years, but The unprecedented fall in global interest rates in the decade
generally refers to leases with greater than 15 years unexpired. that followed the GFC has seen a number of DB pension
For context, 94% of all leases in the UK are now shorter than scheme deficits expand, as the value of their liabilities has
15 years¹ and the average commercial lease duration stands at typically grown faster than the assets on their balance sheets.⁴
8.1 years, (see Figure 1). Retirement providers have increasingly turned to Liability Driven
A lease term of more than 20 years can provide stable, Investment (“LDI”) strategies to manage their interest rate
predictable cash flows for the duration of the lease or and inflation risk, with LDI strategies now forming 54% of the
investment hold. The annual depreciation (and with that, pension market versus 30% five years ago (see Figure 2).⁵
potential capital value fall) associated with a declining lease
term is less impactful for longer leases, especially for unexpired
terms of 25+ years. This offers lower volatility than shorter FIGURE 2 | UK Pension Investment Strategies (£m)
duration leases, where the spectre of pending lease expiry
weighs heavily on asset valuations.
Single-Asset/Specialist LDI Multi-Asset
The MSCI UK Long Income Property Fund Index comprises
3,000,000
£11.18bn² of real estate with most constituent funds seeking
2,500,000
to maintain an unexpired lease duration in excess of 20 years.
Notwithstanding an unbroken quarterly net inflow of capital 2,000,000
into the index over the last 5 years (versus an almost £6bn 1,500,000
outflow of capital from Balanced Funds over the same period)², 1,000,000
this represents less than 8% of the overall MSCI UK Quarterly 500,000
Universe³ and indicates the increasing scarcity of such stock
0
in the market. It is this lack of available investment stock, 2011 2012 2013 2014 2015 2016 2017 2018 2019
rather than any lack of investor appeal, that presents the most
significant barrier to entry into the market.
Source: Investment/Asset Management in the UK. The Investment Association,
September 2012-2020.
FIGURE 1 | Unweighted Lease Length (Years)
Wider factors are underpinning this significant strategic shift
including socio-demographic trends and, in particular, an ageing
10
and growing UK population.
9
A combination of maturing pension schemes, fewer existing
8 workers expected to fund increasing numbers of retired former
7 workers, along with a low returning investment market is likely to
6 widen the funding shortfall (subject to wider market performance).
5
In the current low-yielding environment for UK fixed income,
the liability-driven investor can look towards real assets as a
4
2002 | 2004 | 2006 | 2008 | 2010 | 2012 | 2014 | 2016 | 2018 | 2020 liability-matching alternative to investment-grade credit and
index-linked government bonds.
Real estate – in particular long-income real estate – can meet
Source: UK Lease Events Review (MSCI & BNP Paribas Real Estate, November 2020). both value growth and liability matching objectives with secure
Lease data based on the unweighted full term; ignoring breaks and including
short leases. fixed income-type cash flows (in many cases linked to inflation) and
1 UK Lease Events Review (MSCI & BNP Paribas Real Estate, November 2019). 2 Property Fund Vision Handbook Q3 2020. MSCI/AREF, December 2020. 3 MSCI as at
31st December 2020. 4 PPF 7800 Index. Pension Protection Fund, December 2020. 5 Investment/Asset Management in the UK. The Investment Association, September 2012-2020.
–2–FIGURE 3 | All Property Equivalent Yield vs Gilts vs Base Rate (1998 - 2020)
UK Base Rate All Property Equivalent Yield 10-Year Gilt Yield
10%
8%
6%
4%
2%
0%
1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020
Source: BASE RATE: Bank of England, Official Bank Rate. ALL PROPERTY EQUIVALENT YIELD: MSCI UK. 10-YEAR GILT: Bank of England, 10-year Gilt yield.
capital value growth potential in the long term. The all-property FIGURE 4 | Annualised Total Returns
equivalent yield currently stands at 5.8%⁶ (MSCI UK Long
Lease Funds equivalent yield at 4.5%⁷), representing a 600bps pre-
MSCI UK Long Income MSCI UK All Balanced
inflation yield arbitrage over long-dated UK Gilts (see Figure 3). Property Fund Index Property Fund Index
Real estate has been a staple asset allocation for pension 7%
funds since the early 1970s, with weighted average allocations at 6%
6.0%
5%
c.5% for UK DB schemes.⁸ 4%
According to Aviva Investors’ latest Real Assets Survey, over 3% 3.9%
40% of respondents from insurance companies and pension 2%
2.1%
1%
funds across Europe, North America and Asia (including UK 0%
-1.0%
pension funds) want their allocations to real estate to increase -1%
-2%
and almost half expect to increase investments in long income
12 Month 3 Years
real estate specifically in 2021,⁹ which sits well alongside broader
LDI strategies.
Source: MSCI - Returns to 31st December 2020.
This strategic shift is supported by recent investment
performance (see Figure 4), which shows long-income investors
being rewarded with more attractive risk adjusted returns and FIGURE 5 | Correlation with Traditional Asset Classes
relative out-performance when compared against the MSCI All-
Balanced Funds universe on both a one, and three-year view.
A Diversifying Asset Class UK IG Bonds 0.03
Diversification benefits have long been a driver for real estate
allocations in multi- asset portfolios. The characteristics
typically associated with underlying real estate of income UK Equities 0.31
stability and progression, scope for capital growth and
tangible asset worth – have served to counter the traditional
-1.0 -0.75 -0.50 -0.25 0 0.25 0.50 0.75 1.0
shortcomings of illiquidity and imperfect information. These
positive attributes are emphasised in long-income strategies,
Source: MSCI, January 2021. UK REAL ESTATE: MSCI, IPD UK Quarterly Property Index.
often reducing volatility and resulting in low correlations with UK EQUITIES: FTSE 350 Total Return Index, GBP. UK IG BONDS: S&P U.K. Investment
traditional asset classes (see Figure 5). Grade Corporate Bond Index, Total Return, GBP. (December 2000 - December 2020)
6 MSCI UK Quarterly Property Index, December 2020. 7 MSCI UK Long Lease Funds in Quarterly Universe, December 2020. 8 The Purple Book. Pension Protection Fund,
December 2020. 9 Real Assets Study. Aviva Investors, November 2020.
–3–FIGURE 6 | Annualised Total Returns Income Return:
A Consistent Driver Throughout Cycles
Direct Real Estate Equities Bonds The relative low volatility of real estate is, in part, due to the
8% high proportion of total return derived from income. In the last
6% 6.7%
7.1%
6.7% 20 years, approximately 70% of real estate total return has
5.7%
5.0%
5.4% come from income.¹⁰ Through contractual rent obligations with
4%
3.8% tenants, real estate offers a stable and predictable cash yield
2% to investors through the property cycle. Long and well-secured
1.8%
leased assets are able to provide the greatest certainty.
0%
-1.1% Owing to the potential for income growth, crystallised
-2% through rent review provisions in leases and new lettings,
3 Year 5 Year 10 Year
discounted cash flows from a real estate investment provide a
match to pension scheme liability cashflows that can outstrip
Source: MSCI, January 2021. UK REAL ESTATE: MSCI, IPD UK Quarterly Property Index. conventional UK fixed income. This is even more prevalent with
UK EQUITIES:FTSE 350 Total Return Index, GBP. UK IG BONDS: S&P U.K. Investment index-linked rent review mechanisms, within long, full repairing
Grade Corporate Bond Index, Total Return, GBP.
and insuring (“triple net”) leases where the cost burden rests
with the tenant for the duration of their tenure.
FIGURE 7 | Standard Deviation
Accessing the Long-Income Market
20%
With a predominance of shorter leases being signed across all
18.5%
sub-sectors of the UK commercial real estate market, long-
15%
income investors need to adopt a more creative approach to
10% deal sourcing and execution in order to regularly deploy capital.
The current excess of investor capital over available
5% 6.2% qualifying stock makes it very hard for pension scheme investors
4.9%
to access long-dated real estate unless they have real estate
0% teams active in that area of the market and deep relationships
UK Real Estate UK Equities UK IG Bonds
across all procurement channels. For most investors therefore,
access to market will be via one of the UK long-income real
estate open-ended funds, with entry and exit points on
Source: MSCI, January 2021. UK REAL ESTATE: MSCI, IPD UK Quarterly Property Index.
UK EQUITIES:FTSE 350 Total Return Index, GBP. UK IG BONDS: S&P U.K. Investment quarterly unit dealing days. However, due to current over
Grade Corporate Bond Index, Total Return, GBP.
subscriptions, the time it can take for investors to gain exposure
to the sector can be up to two years.
The key to deal sourcing and execution, and therefore timely
Attractive Risk Adjusted Returns deployment of capital, is ensuring deep and local penetration
Generally delivering less volatility than equities and higher into the market on a comprehensive and nationwide basis via a
total return potential than bonds, UK commercial real estate, in structured and entrepreneurial approach. At Fiera Real Estate,
the wider sense, can offer investors an attractive risk-adjusted we have a one-third ownership stake in 8 regional property
position across their portfolios (see Figure 6 and 7). development businesses covering all of the major commercial
Looking at the standard deviation as a comparable measure hubs around the UK. This provides our long-income fund with
of risk across asset classes, the volatility of real estate appears a first call on funding long leased projects delivered by some
low relative to traditional asset classes. Long-income investing of the most active development businesses in the UK. These
typically carries the lowest volatility of returns across the wider local operating partners provide additional access points to the
real estate market. market in the following key areas:
10 MSCI & Cluttons IM.
–4– ORWARD FUNDING PRE-LET
F How to Manage Risk
DEVELOPMENT PROJECTS Earlier in this paper, we considered how income makes up a large
Occupiers are more likely to make a long- proportion of total return for real estate investors. This is even
term lease commitment on brand new, future-proofed more pertinent for long-income investing where collecting and
assets where occupational obsolescence is low and broader protecting income is the principal determinant of success. Risk
sustainability and technological goals can be factored into management strategies are therefore key for all long-income
the design and development process. As a general rule, the investors with a sharp focus on each of the following areas:
older the building, the shorter the lease commitment.
Where long leases can be secured for new developments,
Tenant Analysis & Credit Risk Management
there is an opportunity for long-income investors to forward
fund such assets at a pre-determined yield, subject to a Counterparty (or tenant) risk is particularly relevant for long-
full pre-letting to a specific tenant or tenants. This type of income real estate where a long lease is a big commitment for
high quality, institutional grade stock is sourced from local both occupier and owner. The owner must be certain a tenant
property developers and therefore managers with the best has long-term plans to stay in occupation and the financial
developer relationships have a significant advantage. strength to service rental payments contracted under the lease.
Tenant risk can be mitigated with a selective acquisition
strategy, rigorous credit analysis (both pre- and post-purchase)
and strong governance processes. A guarantee from a parent
SALE AND LEASEBACKS or group company might also offer additional security of
Successful long-income investors are able to income where the tenant might not be acceptable on its own.
work with large corporations to identify sale A thorough due diligence process and peer evaluation is vitally
and leaseback opportunities across all sub-sectors of the important for good investment, either through rejecting at initial
market. This requires corporate relationships at both local screening or flagging potential issues.
and national levels, in order to identify mission critical Most investors perform this function either via a dedicated
assets where businesses are prepared to enter into 20-year in-house credit risk team or alternatively via third party
leaseback arrangements, allowing them to extract capital credit review and analysis – typically from one of the larger
from their balance sheet for re-investment. accountancy practices. An additional layer of governance, such
as an independent Credit Committee, can further mitigate the
counterparty risk of successful acquisitions.
ALTERNATIVE SECTORS
Positive Correlation with Economic Growth
Whilst leases across all mainstream sub-sectors
and Inflation
of office, industrial and retail have been getting
shorter, lease duration across alternative sectors (such as Rental income linked to inflation (typically annual CPI or RPI) or
hotels, student accommodation, car parks and senior living) contractual minimum uplifts can provide a progressive income
have remained long due to the value occupiers place in each stream that hedges inflation. These provisions are preferable
property as an operational asset. Accordingly, long- income over standard upward-only open market reviews, particularly for
funds tend to have a concentration towards alternative assets DB pension schemes where liabilities are invariably linked to the
to ensure lease duration is maintained at a portfolio level. UK CPI Index.
This has caused some challenges for long income
managers over the past 18 months as government enforced High Quality Real Estate
lockdowns have caused trading to cease. Operators have
been unable to generate “virtual” revenues in sectors Cash flows generated from an investment underpinned by
such as the hotel or leisure markets. This inability to trade, high quality real estate will generally show lower levels of
coupled with a government moratorium on landlord legal occupational and functional obsolescence. High quality can be
action for the pursuit of owed rent has left some managers determined as modern institutional-grade properties that are
exposed. The key in this instance is not to place an over ‘built to last’ and have a valuable alternative use that can be
reliance on operational assets within the underlying real unlocked at the end of the lease term.
estate portfolio but instead focus on Covid “winners” such Longer leases naturally provide more opportunity for an asset
as industrial, logistics and food retail. to physically depreciate (wear and tear) during occupation. Full
–5–repairing and insuring leases place the legal obligation on the to embed ESG considerations into the way we manage our funds
tenant to maintain the property in good condition and to return so that we may drive long-term value and mitigate risk. We are
it in the condition it was in at the start of the lease. This ensures committed to being responsible, resilient and engaged.
future cost exposure is kept to a minimum for the landlord.
Well-Located Assets
Properties in established commercial locations or within urban
areas (close to transport infrastructure and community uses) can
offer greater value protection and liquidity to investors. The risk of
over-renting (where the rent paid exceeds market rent) associated
with long index-linked leases can be reduced, in part, by investing
in areas with strong socio-economic drivers that fuel rental growth. The Key to Successful Investing
Into UK Core Long-Income
Experienced Team with Embedded Processes
Commercial Real Estate
and Strong Track Record
For DB schemes seeking to diversify into real asset
As a heterogenous asset class, it is important to have a
structured process for assessing new opportunities and an investing, long-income UK commercial real estate
experienced team of investment professionals to identify the can provide an appealing option with scope to
right opportunities with appropriate risk- adjusted returns. In a deliver attractive risk adjusted liability-matching
market with low supply relative to demand, having a strong track returns over the longer term.
record and deep access to local markets are key differentiators. That said, the relative strength of investor
demand, coupled with a small and potentially
Active Asset Management declining investible universe creates challenges
Effective asset management is integral to maximising and for new entrants wishing to deploy capital into
defending asset value. A successful investor will monitor an the market.
investment through the lifecycle of ownership including: The key is to identify a manager with a strong
i. Ongoing monitoring of tenant financial strength; track record for delivery and execution, with unique
ii. Active monitoring of investment risk; access points into the market and with a top down
iii. Ongoing review of contractual obligations; sector allocation that minimises exposure to the
iv. Solving technical challenges as they arise and; more at risk operational assets which have, in some
v. Identification of upside opportunity. cases, experienced rental shortfalls during recent
Covid-19 lockdowns. This ensures speedier capital
Environmental, Social & Governance (“ESG”) Focus deployment to access returns.
With recent growth in sustainable and ‘impact’ investing, policy Whilst market access and risk management
centred on the three pillars of sustainability (ESG) now sits at the are paramount, ESG is an area of ever-growing
heart of real estate. importance to investors across the globe. A
The adoption of best practice techniques through an asset’s
well-structured sustainability framework –
lifecycle requires a joined-up approach between owner and
particularly where ESG policy can be tailored
occupier. With the help of a strong managing agent team (as
the principal interface with all occupational tenants), in-house
through development, and sale and leaseback
and external ESG advisors, investment managers can ensure transactions – helps to set apart managers with
consistency when measured against international benchmarks the best credentials.
such as the Global Real Estate Sustainability Benchmark
(GRESB).
At Fiera Real Estate, we recognise the importance of Rupert Sheldon
integrating environmental, social and governance (ESG issues Head of Core REIM
within our investment management processes and the lifecycle Fiera Real Estate UK
of each held asset. We believe that we have a responsibility to
our investors to fully understand the impact of these issues and
–6–About Fiera Real Estate
Fiera Real Estate’s UK division is an investment management provided by Fiera Real Estate. Fiera Real Estate manages
firm, which focuses on both creating and actively managing globally over USD5 billion of commercial real estate through
core assets for investors. The UK business was founded in 1992 its investment funds and accounts.
(as Palmer Capital) and directly manages over £730 million Fiera Real Estate is wholly owned by Fiera Capital
Assets Under Management (AUM). Corporation, a leading multi-product investment-
Its vertically integrated business model has been achieved management firm with more than USD136.7 billion AUM.
by backing eight regional property companies in the UK. Fiera Capital provides Fiera Real Estate with access to global
This has created a pan UK platform of partnerships that investment market intelligence, which enhances its ability to
allows investors to access some of the best deal flow and innovate within a framework that emphasizes risk assessment
entrepreneurial managers within the centralised framework and mitigation.
Contact:
Emma Murray
Business Development Director
emma.murray@fierarealestate.com
07469158805
Rupert Sheldon
Head of Core REIM
Rupert.sheldon@fierarealestate.com
07920151156
info@fierarealestate.com fierarealestate.com
DISCLAIMER
Fiera Real Estate UK Limited and Fiera Real Estate Investors UK Limited (“FRE UK”) has taken all reasonable care to ensure that the facts stated in this presentation are true and
accurate in all material respects. Recipients must rely, however, on their own assessment of the information presented herein.
Certain of the information contained in this presentation has been obtained from published sources prepared by other parties. Neither FRE UK nor any other person assumes any
responsibility for the accuracy or completeness of such information. Other than as set out above, no representation made or information given in connection with any fund, mandate
or asset may be relied upon as having been made or given with the authority of FRE UK and no responsibility is accepted by FRE UK, its subsidiaries or associates or any of their
directors, officers, employees, agents or any other person in respect thereof.
The delivery of this presentation does not imply that the information herein is correct as at any time subsequent to the date hereof.
All statements of opinion and/or belief contained in the presentation and all views expressed and all projections or statements relating to expectations regarding future events or
the possible future performance of any fund, mandate or individual asset represent FRE UK’s own assessment and interpretation of information available to it as at the date of this
presentation. No representation is made or assurance given that such statements, views or projections are correct or that the objectives of any fund or mandate will be achieved.
Recipients must determine for themselves what reliance (if any) they should place on such statements, views or projections and no responsibility is accepted by FRE UK in respect thereof.
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Issued by Fiera Real Estate Investors UK Limited (FRN:229905) authorised and regulated by the Financial Conduct Authority. Registered in England and Wales. Registered Number
04916155. Registered office Queensberry House, 3 Old Burlington Street, London, W1S 3AE.
Fiera Real Estate UK Limited. Registered in England and Wales. Registered Number 01531949. Registered office Queensberry House, 3 Old Burlington Street, London, W1S 3AE.
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