THE CASE FOR EUROPEAN LONG LEASE REAL ESTATE: CONTRIBUTING TO MORE CERTAIN INVESTMENT OUTCOMES

Similar documents
FOR INVESTMENT PROFESSIONALS ONLY. A guide to long lease real estate. Long-dated secure income for institutional investors

Ground rents: an opportunity for institutional investors to diversify exposure

Commercial Property Syndication with Taurus Management Limited

Real Estate Strategies Focus on the European Real Estate Cycle

Thank you for the opportunity to comment on the above referenced Exposure Draft.

Interim statement from the Board of Directors for the first quarter of 2015

Restoring the Past U.E.P.C. Building the Future

Classify and describe basic forms of real estate investments.

Acquisition of Wilkie Edge. Extraordinary General Meeting 23 November 2007

Opportunities and Hurdles for Investors in Light Industrial Properties

Lease accounting 2019 IFRS and US GAAP Preparing for a smooth landing

Rents for Social Housing from

Deloitte Property Index Overview of European residential markets Residential property prices increase

A Guide To Fully Managed Property Investments (0)

Proposed New Accounting Standards For Leases

HM Treasury consultation: Investment in the UK private rented sector: CIH Consultation Response

IASB/FASB Exposure Draft on Leases. Accounting in the Retail Industry A new view of lease accounting emerges

Real estate development significant growth driver Company profile and business model High-quality Investment Portfolio

IFRS industry insights

The Scottish Reforms in an International Context

Changes under IFRS 16

DIFI-Report. Assessment of the Real Estate Financing Market. Germany 1 st Quarter 2019 Published in February 2019

Adviser alert Insights into IFRS 16 Understanding the discount rate

International Research

Interim presentation. 13 July, Anders Nissen, CEO Liia Nõu, CFO

ALE Property Group. Annual General Meeting 13 November Breakfast Creek Hotel, Brisbane, QLD 1

FOR IMMEDIATE RELEASE

Viva Industrial Trust 1Q2018 Results Presentation. 15 May 2018

Social Housing Seminar. 26 April 2018

Applying IFRS. Presentation and disclosure requirements of IFRS 16 Leases. November 2018

Dear members of the International Accounting Standards Board,

GAAP UPDATE DEANA BOWDEN, CPA, MSA WHITE NELSON DIEHL EVANS LLP

Rental income, EUR million Like-for-like growth in rental income, percent

Innovative financing instruments for real estate development in Western Europe

Interim report presentation

Chapter 1 Economics of Net Leases and Sale-Leasebacks

CPI Growth (%)

BUSI 330 Suggested Answers to Review and Discussion Questions: Lesson 10

Housing as an Investment Greater Toronto Area

PROPOSED ACQUISITION OF 107 EUNOS AVENUE 3, SINGAPORE

IFRS 16 Leases supplement

Proposed Accounting Standards Update (Revised), Topic 842: Leases; issued May 16, 2013.

NOTES TO THE FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 MARCH 2017

IASB Exposure Draft ED/2013/6 Leases

Real Estate Principles Chapter 17 Quiz

White Paper of Manuel Jahn, Head of Real Estate Consulting GfK GeoMarketing. Hamburg, March page 1 of 6

Briefing: Rent Convergence

How the lease accounting proposal might affect your company

Interim presentation. 24 April, Anders Nissen, CEO Liia Nõu, CFO

Sale and leaseback how it could benefit your business

The cost of increasing social and affordable housing supply in New South Wales

AIMS AMP CAPITAL INDUSTRIAL REIT MANAGEMENT LIMITED

Reforming the land market

City of Cardiff Council INVESTMENT ESTATE STRATEGY

Rental income, SEK million 1,016 1,040 3,051 3,095 4,109 Growth in rental income comparable properties, percent

Global Real Estate: Similarities & Differences

NON-GAAP FINANCIAL MEASURES

The survey also examines the underlying causes of FVM and impairment audit

March 2014 Dominic Macer, Build to Rent Project Director

Analysing lessee financial statements and Non-GAAP performance measures

New IFRS 15 & IFRS 16 standards The impact on M&A transactions. New IFRS 15 & IFRS 16 standards The impact on M&A transactions

Rental income, EUR million Like-for-like growth in rental income, percent

The joint leases project change is coming

Gearing up for change New IFRS on Leases

Countdown to MFRS 16 Are you ready?

August 2012 Design by Anderson Norton Design

IASB Exposure Draft ED/2013/6 - Leases

COMMITTEE OF EUROPEAN SECURITIES REGULATORS

Shipping insights briefing

Broker. Investment Real Estate. Chapter 15. Copyright Gold Coast Schools 1

NORTH BRIDGE NORDIC PROPERTY AS

AUDIOCAST PRESENTATION Q1/2018

NRE: Creating Value for Shareholders. March 13, 2018

Sector Scorecard. Proposed indicators for measuring efficiency within the sector have been developed for the following areas:

Vauxhall Sky Gardens Wandsworth Road London SW8

The Real Estate and Land Market of Russia: Factors of the Sustainable Development

Presentation for REITs Symposium 2016

Real estate leases. How will IFRS 16 impact real estate entities? May 2016

Extraordinary General Meeting 19 June 2012 ARA-CWT Trust Management (Cache) Limited KNOWING. BELIEVING. DELIVERING

First Sponsor Group Limited Investor Presentation 24 July 2015

Headline Verdana Bold The evolutions of leases accounting under IFRS 16 Mariano Bruno, Carlo Laganà, Giuseppe Ambrosio, Deloitte & Touche S.p.A.

3 November rd QUARTER FNB SEGMENT HOUSE PRICE REVIEW. Affordability of housing

Rental income, SEK million 1,071 1,014 4,122 4,109 Growth in rental income comparable properties, percent

FÉDÉRATION FRANÇAISE DES SOCIÉTÉS D'ASSURANCES

Economy. Denmark Market Report Q Weak economic growth. Annual real GDP growth

The role of policy in influencing differences between countries in the size of the private rented housing sector Professor Michael Oxley 26/2/14

Soaring Demand Drives US Industrial Market to New Heights

Market rent. The rationale and out approach. James Gibson Sovereign Housing

LANDLORDS CAUTIOUS AHEAD OF TAX CHANGES

The Impact of the financial Crises on Housing Cooperatives in Europe

Rental income, EUR million Like-for-like growth in rental income, percent

AFFORDABLE HOUSING - Finance and Governance May Adrian Harrington Head of Funds Management, Folkestone

OUE Commercial REIT s Portfolio To Exceed S$3.0 Billion With Proposed Acquisition Of Indirect Interest In One Raffles Place

DREAM GLOBAL ANNOUNCES FOURTH QUARTER RESULTS, 24% ANNUAL NET ASSET VALUE GROWTH AND OVER 6% FOURTH QUARTER COMPARATIVE NOI GROWTH

Why IFRS 16 matters to the shipping industry

New Accounting Rules for Revenue and Leases

Research. A Capital Value production. An analysis of the Dutch residential (investment) market 2017

WYOMING DEPARTMENT OF REVENUE CHAPTER 7 PROPERTY TAX VALUATION METHODOLOGY AND ASSESSMENT (DEPARTMENT ASSESSMENTS)

Financing Capital Expenditures

Investment Guide. home loans

Transcription:

This document is for professional/qualified investors only. It is not to be distributed to or relied on by retail clients. THE CASE FOR EUROPEAN LONG LEASE REAL ESTATE: CONTRIBUTING TO MORE CERTAIN INVESTMENT OUTCOMES

Contents Introduction 3 Defining long lease real estate: putting the lease structure centre stage 4 Adding greater certainty over the timing and scale of cash flows 5 Risk and return characteristics 8 Roles of European long lease real estate in diversified portfolios 9 Key portfolio considerations 10 Conclusion 11

Introduction INTRODUCTION In today's low yield world, high quality assets generating predictable income streams with inflation-linked uplifts are highly prized by investors. The search for income is intense in continental Europe, where the European Central Bank has been using conventional and unconventional policy to maintain liquidity and suppress borrowing costs since 2009¹. One outcome has been a rush of interest in alternative assets, including real estate, which can generate higher yields than liquid alternatives and help enhance risk adjusted returns. Long lease real estate let to high quality tenants has distinctive advantages for long-term institutional investors who are challenged to meet their return requirements through traditional investment strategies. With the 10-year German bund yield languishing under 1 per cent, long income yields of four per cent and higher have obvious appeal². Long lease real estate can: Achieve more predictable and less volatile returns compared to traditional real estate: the core focus is on the stability, reliability and longevity of income streams. Provide inflation protection, which can be helpful for investors with liabilities to match in real terms. Offer an illiquidity premium, contributing to higher yields than traditional fixed income assets. Enhance protection against a default of the underlying company by offering recourse to the property. The case for European long lease real estate explains how adding long lease real estate to a diversified portfolio can bring investors greater certainty over the timing and scale of cash flows. It explores how the asset class can be used as an alternative or supplement to holding traditional fixed income assets, and the potential impact on a portfolio s risk/return profile. Although property is less liquid than exchange-traded assets, the resulting yield uplift can be attractive for investors with long term horizons. ¹ Source: European Central Bank Monthly Bulletin, as at June 2009 ² Indicative yield, based on pipeline transactions. Source: Aviva Investors, as at December 2017. Aviva Investors The case for European long lease real estate: Contributing to more certain investment outcomes 3

Defining long lease real estate; putting the lease structure centre stage The primary focus is on the lease credentials on its length, amount of inflation protection and the strength of the lessee s covenant. DEFINING LONG LEASE REAL ESTATE: PUTTING THE LEASE STRUCTURE CENTRE STAGE Long lease structures provide longevity. Lease lengths in this segment of the market in continental Europe are normally at least 15 years compared to around five years for traditional real estate. The contracted income stream is a major component of the value of long lease property. For this reason, long lease real estate is sometimes referred to as high lease value property. Compared with conventional real estate, little or sometimes no value is derived from the reversion of the lease after the contract s expiry. Secondly, tenants tend to offer strong covenants and low default risk. The lessees are typically governmental bodies or institutional-grade³ companies. Thirdly, rents are usually linked to the Consumer Price Index (CPI), or another form of indexation, which is likely to protect the income stream against inflation. Due to these characteristics, there are significant differences in the investor s decision making process compared with traditional real estate. For a long lease real estate investor, the primary focus is on the lease credentials including length, level of inflation protection and covenant strength. Factors such as location and building quality are of less importance. Consequently, returns are largely driven by bond-like income return rather than equity-like capital return. In contrast, traditional real estate investors typically focus on how challenging it could be to let (or re-let) a building. In this scenario, location, microlocation and building quality are very significant, as are the opportunities that might arise from active management from changing the tenant mix, refurbishing or redeveloping the property. The characteristics of the lease itself are relevant but not as significant as for long lease real estate. In traditional real estate, the capital return accounts for a higher share of total return than long lease real estate. ³ Institutional-grade: Companies with one or more of the following characteristics: an investment grade credit rating, public sector support from an investment grade sovereign, financial performance akin to investment grade entities in operating margin, gearing, and/or revenue. Source: Aviva Investors 4 Aviva Investors The case for European long lease real estate: Contributing to more certain investment outcomes

Adding greater certainty over the timing and scale of cash flows ADDING GREATER CERTAINTY OVER THE TIMING AND SCALE OF CASH FLOWS In continental Europe, traditional property is typically subject to CPI-linked rent reviews. Income may be affected by void periods when leases end or tenants default. The asset is re-leased based on market conditions at the time. Sale proceeds can vary due to the cyclical nature of the real estate market, and the amount and timing of the cash flows are similarly uncertain. (See Figure 1, below.) Figure 1: Cash flow from traditional real estate - a CPI-indexed 5-year lease Cash flow Uncertain sales proceeds CPI-linked uplifts Void period? New lease level???? Rent level agreed at outset, paid monthly Source: Aviva Investors for illustrative purposes only. Investors in long lease real estate have greater certainty about real expected returns than investors in traditional real estate. Aviva Investors The case for European long lease real estate: Contributing to more certain investment outcomes 5

Adding greater certainty over the timing and scale of cash flows Rents on long lease property assets are also typically linked to CPI. The lease is signed with an institutionalgrade tenant and the strength of the covenant determines the lease terms offered (such as the lease length and rent). The impact of the sale proceeds on returns is reduced due to the extended term of the lease. This allows investors to sell assets when they stabilise, i.e. when they are fully leased, and have a relatively long unexpired lease term. (See Figure 2, below.) Figure 2: Cash flow from long income real estate (A CPI-indexed 15-year lease) Cash flow CPI-linked uplifts Reduced uncertainty about sales proceeds due to the asset being sold with a 5-year unexpired lease in place??? Extended term, rent level agreed at outset, paid monthly Source: Aviva Investors for illustrative purposes only. 6 Aviva Investors The case for European long lease real estate: Contributing to more certain investment outcomes

Adding greater certainty over the timing and scale of cash flows A long lease can also be structured in such a way that the property is passed back to the tenant upon expiry. As a result, there is no impact of the sale proceeds on return if the asset is held to maturity. This is referred to as a fully amortising lease investment, shown in Figure 3, as the value of the property is fully written down over the lease term. Figure 3: Cash flow from fully amortising long income real estate (A CPI-indexed 15-year lease) No sale proceeds (known at outset) Cash flow CPI-linked uplifts Source: Aviva Investors for illustrative purposes only. Extended term, rent level agreed at outset, paid monthly Key considerations for real estate investors Traditional Location Market conditions Building quality Long lease (mature) Lease length Covenant strength Inflation protection Lease length Secondary considerations: covenant strength and inflation protection Secondary considerations: location, market conditions and building quality Aviva Investors The case for European long lease real estate: Contributing to more certain investment outcomes 7

Risk and return characteristics RISK AND RETURN CHARACTERISTICS 1. LOWER RISK THAN UNSECURED DEBT Investors in long lease real estate derive most value from the income associated with the lease. They carry less exposure to the changing capital value of the asset, which is typically hard to predict. Focusing on strong covenants helps minimise default risk. Even if a default does occur, the investors are secured creditors. They face the same default risk as corporate bond holders, but with recourse to the underlying property. 2. RETURNS RELATIVE TO LIQUID ASSETS Real estate assets are significantly less liquid than bonds and many investors naturally require a premium to reflect this. However, for investors seeking long term, largely predictable income streams, the lower level of liquidity tends not to be a prime concern. Indeed, long-term investors may benefit, since the outcome tends to be a higher income return compared to corporate bonds with the same credit risk.3 3. INFLATION PROTECTION Long lease continental European property assets, with their explicit links to inflation, can be a good match for institutional investors liabilities and cash flows. The strength of inflation protection varies market-bymarket. As investors are secured creditors, they face the same default risk as corporate bondholders, but with recourse to the underlying property. 8 Aviva Investors The case for European long lease real estate: Contributing to more certain investment outcomes

Roles of European long lease real estate in diversified portfolios ROLE OF EUROPEAN LONG LEASE REAL ESTATE IN DIVERSIFIED PORTFOLIOS Long lease real estate can play a number of useful roles in diversified portfolios, helping to de-risk property exposure and supplement fixed income holdings. DE-RISKING PROPERTY EXPOSURE Long lease real estate is a comparatively low risk form of property investment, due to its focus on lease term and the quality of tenants. Property investors may therefore reduce the overall risk of their portfolios through selective exposure to long lease real estate. Property investors may be particularly minded to increase their allocation to long lease real estate when they view the prospects for occupier markets in traditional real estate to be weak or negative. At these times, a focus on long lease real estate could be beneficial for portfolio performance. PROVIDING AN ALTERNATIVE TO FIXED INCOME Low interest rates and quantitative easing have made it difficult for insurance companies, private and public pension funds and other portfolio managers to meet their return requirements within their risk budgets. It has also made de-risking from equities to government bonds more difficult. As a result, many institutions have been increasing their allocation to alternative asset classes, including real estate. Another driver of demand is the short supply of index-linked government bonds in some European markets. These assets typically offer a good match for institutional investors' liabilities and cash flows. In Germany, inflation-linked federal bonds and notes accounted for just 7 per cent of total tradable government debt at the end of 2017⁴. This ratio is a little higher in France -13 per cent as at the end of 2018⁵. This compares with 25 per cent share of index-linked gilts as a portion of the wider UK gilt market⁶. Long lease real estate can help bridge any mismatch between supply and demand for index-linked bonds. Underfunding has become a dominant issue for corporate pension schemes in a number of European countries. Reallocating some exposure from traditional fixed income to long lease real estate might allow these pension funds to achieve higher returns without taking on increased risk, aside from illiquidity. ⁴ Federal Republic of Germany Finance Agency, as at 24 September 2018 ⁵ Agence France Tresor, as at 24 September 2018 ⁶ United Kingdom Debt Management Office, Quarterly Review April - June 2018, as at 24 September 2018. Aviva Investors The case for European long lease real estate: Contributing to more certain investment outcomes 9

Key portfolio considerations In a downturn, long lease real estate is likely to behave defensively relative to traditional real estate." KEY PORTFOLIO CONSIDERATIONS In general, it would be expected that long lease real estate would provide slightly lower returns than traditional real estate, but with significantly less volatility. In a downturn, the UK experience suggests that long lease real estate is likely to behave defensively relative to traditional real estate and may outperform. (As explained previously, there are few established European long lease comparators.) For example, the volatility of returns from UK long lease real estate was lower than the IPD All UK Direct Real Estate Index between 2005 and end of June 2018, with less pronounced peaks and troughs (see Figure 5, below). The standard deviation of total returns in this period was 2.16 per cent for long income, and 3.63 per cent for the property market as a whole. As might be expected, total returns on long lease real estate were lower than on all direct real estate in 2005 to 2006 and 2010 to 2016, but higher during the downturn of 2007 to 2009. Figure 5: Lower volatility of returns from UK long income than the wider UK market 15 10 5 0-5 -10-15 1/6/05 1/12/05 1/6/06 1/12/06 1/6/07 1/12/07 1/6/08 1/12/08 1/6/09 1/12/09 1/6/10 1/12/10 1/6/11 1/12/11 1/6/12 1/12/12 1/6/13 1/12/13 1/6/14 1/12/14 1/6/15 1/12/15 1/6/16 1/12/16 1/6/17 1/12/17 1/6/18 IPD All UK Direct Real Estate IPD UK Long Income Source: IPD, as at September 2018 Adding long lease real estate can therefore improve the defensive credentials of a traditional real estate portfolio, as well as increasing its diversification. When added to a portfolio of liquid assets, it can provide comparable diversification benefits to traditional real estate, while helping investors to match their liabilities and/or cash flows more effectively. 10 Aviva Investors The case for European long lease real estate: Contributing to more certain investment outcomes

Conclusion CONCLUSION We expect the demand for long income real estate to remain robust. In part, this reflects the ongoing growth of liability-driven and cash-flow driven investment and the continued search for alternative investments with fixed-income-like characteristics. Institutional investors, such as insurance companies as well as public and private pension funds are particularly likely to look at ways to de-risk their property exposure, as they move from investing in real estate for growth to holding property exposure for secure income. Leases with inflation linkages continue to be highly sought after in a market where there is a scarcity of inflation-linked investments. Although yields on long income real estate are lower than at any time in the past, the premium relative to low-risk fixedincome remains attractive. In continental Europe, long income yields of four per cent or higher are available⁷, compared with the 10-year German bund yield of below 1 per cent. ⁷ Indicative yield, based on pipeline transactions. Source: Aviva Investors, as at 31 March 2017 Aviva Investors The case for European long lease real estate: Contributing to more certain investment outcomes 11

CONTACT US AT : Benelux Aviva Investors WTC Amsterdam H-Toren, 4th Floor Zuidplein 36 1077 XV Amsterdam The Netherlands Tel: +31 30 799 1150 Germany Aviva Investors An der Hauptwache 7 60313 Frankfurt am Main Tel: +49 69 2578 26 0 Nordics Aviva Investors Strandvägen 7A 114 56 Stockholm Sweden Tel: +46 (0) 8 58610792/93 France Aviva Investors 14 rue Roquépine 75008 Paris Tel: +33 (0)1 76 62 90 00 Luxembourg Aviva Investors 2 rue du Fort Bourbon, 1st Floor P.O. Box 1375 L-1013 Luxembourg Tel: (+352) 40 2820 261 United Kingdom & Ireland Aviva Investors St Helen s 1 Undershaft London, EC3P 3DQ Tel: +44 (0) 20 7809 6000 www.avivainvestors.com Important Information Unless stated otherwise, any sources and opinions expressed are those of Aviva Investors Global Services Limited (Aviva Investors) as at 25 September 2018. This commentary is not an investment recommendation and should not be viewed as such. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Past performance is not a guide to future returns. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Aviva Investors Global Services Limited, registered in England No. 1151805. Registered Office: St Helen s, 1 Undershaft, London EC3P 3DQ. Authorised and regulated by the Financial Conduct Authority. J24913 - RA18/0987/01102019