Don’t Spread Yourself too Thin

Published on 2012/11/05

A recently published poll by Union Investment would be nothing short of sensational if the findings turned out to be representative: Germany’s institutional investors supposedly tripled their real estate ratio from 5% to 15%! To be quite honest, I’m a bit sceptical, for I cannot begin to imagine how this is supposed to have been accomplished within a short period of time. If major investors such as Allianz or Bayerische Versorgungskammer decided to jack up their real estate ratio by as much as one or two percentage points, putting their money where their mouth is would require massive acquisitions and a major effort to initiate the acquisitions. By the same token, reducing their bond holdings by 28 percentage points strikes me as excessive. But even if the figures turned out to be less than representative, and that the real estate ratio “merely” doubled, rather than tripling, it would still be a sensational piece of news.

In every poll conducted by Feri or Ernst & Young Real Estate over the years, institutional investors in Germany stated their intention to raise their real estate ratio – though not as dramatically as this. Whatever increases did occur tended to be on a much smaller scale than previously announced.

Now, many of the institutional players appear to have realised that raising the real estate ratio, say from four to six percent, would do nothing at all to alter the overall performance of their investments. For many insurance companies, the situation is quite dramatic, because they are committed to investment performance guarantees that are impossible to meet with their present high share of bond holdings. If you wish to remedy the situation by stepping up your real estate investments, then you should not spread yourself thin, but make massive commitments.

What would actually stand in the way of raising the real estate ratio to, say, 25%? It would in any case be legal to do so. The argument that there is simply not enough real estate to go around – an argument often fielded in the past – does not hold water. First of all, no one is forcing the institutional players to invest in Germany only. Secondly, no one is forcing them to commit 60% or 70% of their investments in office property. Thirdly, the wind-up of several open-ended real estate funds has put an ample supply of interesting properties on the market. Fourthly, Germany’s open-ended and closed-end real estate funds – once the most potent investor group on the German real estate market – are out of the game except for a selected few who continue to compete for lucrative acquisitions.

Institutional players tend to take a rather uniform approach: Once a certain trend emerges, everyone jumps upon the bandwagon – the logic being that you cannot go wrong if everyone else is doing the same thing, and that, if things were to go wrong after all, you would still have the perfect excuse. It is not a particularly clever argument. Yet it is precisely this kind of investment behaviour from which real estate stands to benefit. If the trend continues – and does so not just in Germany – it will keep putting considerable pressure on real estate returns. And in the medium term, it will cause a bubble to form on the real estate market that will trigger upheavals somewhere down the road whose impact will go far beyond the real estate markets.

Before then, however, years will have passed during which project developers and other providers of real estate products can rejoice over the brisk demand. Issuers of specialised real estate funds are also likely to benefit from the rally, as are providers of asset management services. For even if many institutional players have lately returned to direct investments, they will soon reach the limits of their in-house management capacities, and be increasingly forced to contract third-party management, e.g. when it comes to residential investments.

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