Real estate is an inherently risky investment class, as the last global downturn proved. How to manage that risk is one of the profession’s most pressing challenges.
1 September 2017
It was a $364bn meeting. That was the value of global real estate controlled by the investors around the table at RICS’ London HQ where representatives of leading global investment funds had convened for the first session of the RICS Global Investment Risk Management Forum. They had been invited by the then-RICS president, Martin J Brühl FRICS, to exchange best-practice advice, and perhaps also lay the foundations for an industry-endorsed approach to investment risk management.
As Head of International Investment Management at the German fund manager Union Investment Real Estate, risk management is a primary preoccupation for Brühl. That was one reason why he chose to make it a key theme of his year as RICS President. The other was that he felt that RICS was ideally placed to make a difference, as an internationally respected body and a source of professionalism, thought-leadership and ethics for investors around the world.
“Eight years after the crash, we were talking about the potential overheating of the market,” Brühl explains. “I thought it was important to bring people together to show the world that we have learned, that we do have best practice in risk management. I think RICS is the right forum.”
Given the unstable nature of 2016’s global political events, Brühl’s initiative has never been more timely as investors seek more stable assets such as real estate. Banks, insurers and pension funds must all meet tougher regulatory requirements imposed since the crash, but property is not as stringently regulated as other asset classes and its risk management procedures are less well developed.
“If I go to an emerging market in Asia and I learn that someone is RICS accredited, that gives me some serious confidence. That’s the kind of power RICS can bring” - Philip Barrett, PGIM Real Estate
Buildings are unique, so real estate risk management is more labour intensive: “If you were to look at one of our investment committee books, it would include extensive details about the asset, location, rent roll, lots of pictures – everything you would expect if someone is considering investing in a piece of real estate,” says Barrett. “But there will be a separate section on what we consider the key risks and mitigants against that risk. The fun bit is you have to do that on an asset-by-asset basis.”
Barrett has noticed a greater focus on risk management from investors, owners and regulators, and he believes RICS has an important role to play. “If I go to an emerging market in Asia and I learn that someone is RICS accredited, that gives me some serious confidence. That’s the kind of power RICS can bring to it – there aren’t that many global organisations in our industry.”
Capital is now flooding into real estate, particularly into core markets in Europe, as historically low interest rates across Europe, the US and Asia-Pacific are driving investors to seek higher returns elsewhere. Sovereign wealth and pension funds are increasing their real estate allocations, while the relaxation of foreign investment rules in markets such as Taiwan has unleashed some significant new players. Meanwhile, high-net-worth individuals from around the world are flocking to real estate in core markets as a safe haven for their wealth.
“The investment industry changed completely between 2012 and 2015,” says Jan-Willem Bastijn MRICS, Chief Executive of the EMEA capital markets group at Cushman & Wakefield in Amsterdam. “Where it was probably international and cross-border before the global financial crisis, it is now completely global. Money flows are coming from all parts of the world, not just the ones that we know quite well.” In the real estate marketplace of today, assessing the source and associated risks of capital has become more important than ever before: “You always had to do that, but now we like to understand not just the face that we see in the market, which might be the investment manager or the front line of the investor, but also the money behind that investor. That's a massive game-changer,” adds Bastijn.
The increasing diversity of capital has brought a more sophisticated approach, says Tony Martin MRICS, Head of Investment Advisory at CBRE, from investors who are now more likely to target a particular area of the market. He has noticed greater demand at both ends of the risk curve. “The desire for long-term, lower-risk assets has increased – for example, ground-rent funds have risen in number and scale since 2007. Meanwhile, opportunistic, high-risk funds have also increased in scale as they seek to take advantage of the market coming back.”
With so much capital flooding into core real estate markets, investors are also having to look further afield to less-established destinations to achieve the right level of returns. Investors have always sought to diversify portfolios to insulate themselves against peaks and troughs in individual markets. The challenge is to identify genuinely non-correlated assets, notes Martin. “What 2007 showed is that most assets were correlated with each other in some way. If you’re going to have a 100-year or 200-year crash, you find that what were previously thought of as groups of assets with low correlation are in fact more closely correlated.”
Interest among investors is growing in alternative sectors such as private-rented residential, self-storage, student housing and healthcare. Joe Guilfoyle MRICS, Head of Corporate Transactions at JLL Alternatives, says: “Institutions are, in part, being forced to look at new products as traditional sectors do not have enough assets for the weight of equity chasing it. Also, as we move through the cycle, investors are looking for properties that have more defensive qualities. Alternatives provide these because they’re underpinned by very strong supply-and-demand dynamics.” Historically, alternatives would constitute around 10% of institutions’ real estate allocation in the UK, says Guilfoyle, but this is forecast to reach 28% by 2019.
The key is that these sectors have an operational element, where a good manager can outperform the market and increase the value of the asset. The caveat, however, is that investors cannot afford to take their eye off the ball: “Once investors have taken the decision to invest, proactive management to maintain those cashflows is absolutely essential,” comments Guilfoyle. “The better managers maintain a continual investment in their asset.”
Diversification also makes the work of risk management more complex, because maintaining the correct level of exposure requires constant monitoring. “One of the key aspects is managing that risk and making sure that changes in the risk profile don’t creep up on you,” warns Martin. “It’s an ongoing process. Where people sometimes go wrong is that they buy a portfolio and then sit on it. What they don’t realise is that their risk profile is not constant and will change. It is important that real estate strategies are monitored and then adapted to changing conditions.”
All of this activity is driving demand for internationally recognised standards in areas such as valuation to improve transparency and confidence for investors. “Valuation is one of the key areas of risk management – investors want to make sure they are paying a fair price,” says Nicholas Talbot, Chief Executive of the International Valuation Standards Council (IVSC). “If a valuation has been done improperly, by someone who is not a professional or not to a consistent standard, the real value could turn out to be much lower than the price you paid.
“Even if investors have their own risk management processes in place, and their own in-house valuers carrying out checks and balances, there could still be situations where people are trained to different standards and levels of professionalism,” Talbot adds. “In a seamless, ideal world, you would have a single approach so you know you’re comparing apples with apples.”
The IVSC has succeeded in rallying some of the world’s largest valuation organisations behind its initiative to develop a common approach to valuation practices. In the longer term, this is what Brühl hopes to achieve with the RICS Global Investment Risk Management Forum. There is plenty of best practice in the profession already – now he is seeking to bring industry leaders together to compare notes and learn from each other. “We won’t be able to prevent the next crash or the next crisis, but we can start to influence the market,” he says. “Hopefully it’s going to advance the industry and contribute to market confidence.”
After all, $364bn may only be a fraction of the money around the global real estate investment landscape, but you always have to start somewhere.
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