2012 Real Estate Symposium Main Panel Report: Assessing Risk and Return in a Global Real Estate Market
By Uche Akujuo EMBA’13 and Andrew Joyner ’13
|Moderator:||Lynne B. Sagalyn, Earl W. Kazis and Benjamin Schore Professor of Real Estate and Director, Paul Milstein Center for Real Estate, Columbia Business School|
|Panelists:||Peter Ballon, Vice President, Head of Real Estate Investments—Americas, Canada Pension Plan Investment Board (CPPIB)
Adam Gallistel ’04, Senior Vice President—Head of Brazil, GIC Real Estate
James A. Stolpestad II, CEO, Allianz Real Estate of America
The closing panel for all Symposium attendees centered on how some of the largest and most active institutional real estate investors think about allocating capital. Serving as moderator, Professor Sagalyn continually asked about approaches to real estate investing and what criteria shaped decision-making. Speaking to these issues were three panelists whose companies collectively manage tens of billions of dollars in real estate. One commonality that emerged was their increased focus on developing growth markets.
Despite the similarities among these very large and influential investors, each fund has a different approach to investing. CPPIB is not a sovereign fund, so investment decisions are not in the hands of the government. Its overall mandate is to provide the future pensions of contributors and beneficiaries by maximizing returns without undue risk of loss. The fund pursues an active portfolio management strategy and does not have portfolio target allocations. CPPIB does not pursue a diversification model but rather is focused on incremental risk and return, with a global basket of allocations at 65 percent and 35 percent toward equity and debt, respectively. As a global organization with “no home,” the fund is agnostic to investment geography.
GIC is a sovereign wealth fund established by the government to manage Singapore’s foreign reserves. Its mission is to preserve and enhance the international purchasing power of the reserves (and therefore it cannot invest in Singapore), with the aim to achieve good long-term returns above global inflation as compared to a basket of currencies. Overall fund-level investment return requirements are expressed in real terms; however, each investment is required to achieve returns that vary widely depending on risk profile and/or location. GIC continues to grow its real estate exposure in emerging growth markets. However, developed economies have and will continue to be an important part of the portfolio.
Allianz invests to match and earn excess return to fund liabilities from its insurance products. Portfolio managers from each of the company’s 300 insurance subsidiaries determine investment allocation contributions toward real estate investments. Real estate is used to diversify away from Allianz’s fixed-income portfolio, increase returns, and provide an inflation hedge. Allianz will always maintain large portfolio holdings in Europe, where many of its portfolio insurance companies operate, but also seeks increased access to emerging markets. Finally, comfort with investments is important because of the conservative culture of the firm.
The discussion next shifted to the constraints and opportunities of managing such large pools of capital. GIC focuses on countries with a large enough investable real estate stock to make the investment in time and human capital worthwhile in the long run. Thus, the threshold minimum investment volume in any one country is at least a “few hundred million.” GIC is already invested in approximately 40 countries. GIC expects pricing compensation for illiquid, nontransparent markets. The United States, Asia, and Europe will continue to be GIC’s largest markets. Among growth markets, GIC is invested in Mexico, Brazil, China, Russia, and Turkey. CPPIB is also focused on going deep into markets. It prefers joint ventures (to the tune of 95 percent of its deals) with strong local partners who provide operational expertise. Allianz tends to focus on transparent, liquid markets.
Each fund approaches benchmarking real estate differently. Allianz is largely focused on outperforming the IPD or NCREIF indices for direct equity investments and the Barclays bond index for debt investments. GIC uses a total return benchmark. CPPIB must outperform what is being sold from its passive portfolio of equities and fixed income to fund the real estate investment opportunity being put forward to the investment committee.
The panelists also discussed their respective approaches to managing currency risk. At the real estate level, GIC does not hedge against the U.S. dollar when underwriting its investments and instead evaluates each investment in local currency terms, while the treasury group at Allianz decides whether to hedge against a basket of currencies or leave investments unhedged.
By and large, the real estate groups at each institution are more focused on private real estate versus public real estate securities. At CPPIB, the equities group manages all public real estate securities. The Allianz real estate group is focused on the private market debt and equity investments, and it is influenced by what the company’s equities division invests in. The GIC real estate group invests both directly and in public real estate securities. However, when looking at listed real estate companies, it tends to consider smaller companies outside the MSCI indices so as to not overlap with the equities team. The GIC real estate team looks at whether public-private arbitrage is possible if public deals look cheap relative to private deals and vice versa.
Tax structuring is important as these firms make investment decisions. GIC views the United States as the most complicated tax jurisdiction and finds itself facing anywhere from zero tax to a 60 percent tax rate depending on the transaction (foreign sovereigns are tax-free on passive investments but taxable on commercial activities). GIC does not have a tax treaty for reduced rates or exemptions with the U.S. government, something that is a competitive issue as many large institutional investors such a pension funds, endowments, and foreign investors with tax treaties enjoy far more favorable tax positions. CPPIB, too, finds the United States to be a challenging tax environment for foreign buyers. CPPIB prefers markets in which there is an even playing field on tax, such as Brazil, where the tax basis is the same for foreign and domestic firms. At Allianz, tax is considered very important. There are different net returns after tax for investors of different nationalities, so Allianz seeks capital sources to minimize tax drag and maximize returns.
These large investors in many instances use operating partners to execute their investment strategies. The CPPIB model hinges upon operating partners, with the selection of operating partners viewed as the single most important element of its investment process. CPPIB spends more time underwriting its investment partner than the real estate. Alignment is key, and CPPIB seeks to achieve this through 50-50 equity co-investments. Allianz does not use operating partners in Europe because of its deep bench and strong expertise in the region, but in other markets, Allianz examines the attributes in which partners could add value and then ranks the partners.
The low interest-rate environment is generally unwelcome by this group of investors. GIC views the cap rate spreads to borrowing costs as attractive today, but as borrowing costs and inflation rise in the future, cap rates will rise and chip away at profits unless significant growth occurs. For this reason, GIC is cautious in underwriting U.S. investments as they feel that moderate growth and a reversion to the mean on interest rates are likely in the longer run. CPPIB, which typically does not use leverage, dislikes low interest rates because they destroy the firm’s competitive advantage. CPPIB sees deals in the market driven by current debt costs and is taking a pass on such deals.
The panel concluded with a question-and-answer session during which the discussion ranged from risk tolerance to whether the European crisis represents a net opportunity or a net risk. Views on risk diverged. Some are more comfortable in core markets where they understand risk, while others are focused on whether they are being adequately compensated for taking risks in emerging markets. The panelists see an opportunity in Europe to provide debt—all-cash acquisitions or in the mezzanine space where lending has evaporated—as few lenders are active in the market, especially higher LTV loans.
The fifth annual Real Estate Symposium took place on December 4, 2012, at Columbia University's Faculty House, with more than 180 alumni representing classes from 1961 to 2012. Please visit the event page for more details and reports on other speakers. Hosted by the Paul Milstein Center for Real Estate and the Real Estate Circle of Columbia Business School, the Real Estate Symposium is an annual educational forum that brings together accomplished Columbia Business School alumni and top industry leaders for a broad-based discussion of topical issues, high-profile transactions, trends, and challenges facing the real estate industry.