Aviva: a smarter investor?

Two years ago, some observers expected Aviva to withdraw from investment management. Today, the company has one of the best portfolios of development projects in London.

Which developer is sitting on 1m sq ft of London development pipeline, most of which is above or next door to Crossrail stations?

Aviva would surely be few people’s first answer, but the UK institution finds itself with one of the best pipelines of London projects of any investor whose strategy is to take advantage of the capital’s new east-west rail link, which will open in three years’ time.

It isn’t so much that Aviva has outbid every other investor to buy sites over the past few years. Like most of the big UK fund managers – and arguably even more than most, given the huge corporate change it has recently undergone – Aviva has struggled to get money into the London market, owing to the flood of overseas capital that has driven up prices. But while the giant pensions group has been busy reinventing itself after a torrid few years – with new management, new strategies and mega-mergers – the real estate team within Aviva Investors has quietly got on with exploiting the rich seam of opportunity that has arisen thanks to its long-term status as a major owner of London property.

The strategy, according to head of central London Neil McLeod and managing director for European direct investment Ben Stirling, has been to transform long-held and somewhat unloved buildings into first-class assets, rather than competing to buy prime stock at ever-lower yields. With the prospect of a significant injection of real estate AUM on the horizon – thanks to the ongoing Friends Life takeover, coupled with the revolution in the fund management industry the government’s radical pension changes are about to unleash – that strategy looks likely to serve the business well.

“Like most institutions, we have plenty of equity to deploy. So I think our preference, certainly over the past few years, has been: if you’ve got existing stock, you are better off putting money into that rather than just sticking it back into the market and competing with everybody else,” says McLeod, sitting in the marketing suite across the road from Fitzroy Place. “It is quite an efficient way of deploying equity into the market.”

Of course, with an institution the size of Aviva – the business manages real estate assets of about £24bn – single statements are rarely true, given the diverse nature of the funds it manages, and Fitzroy Place is not part of this make‑good-and-mend approach. Instead Aviva did outbid the market to secure the prized site in 2010 – albeit with the twist that Icelandic bank Kaupthing stayed in the deal instead of selling entirely – and it was a decision that has been more than justified.

The joint venture partners, together with developer Exemplar, underwrote the 235-home residential element of the scheme at values of around £1,500 per sq ft and the 220,000 sq ft of offices at rents of just under £60 per sq ft.

With just one home and 80,000 sq ft of offices as yet unaccounted for, the partners have actually achieved average sale prices of more than £1,900 per sq ft on the flats and office rents of £80 per sq ft, which will rise once the second building is let.

The success has reinforced the long‑held Aviva view that development is a key part of its DNA, albeit with the recognition that such perfectly timed opportunities do not come along all that often.

“This has probably been the most exciting project of my entire career,” says McLeod. “But historically we have done a lot more development than our peer group, so it is a strategy that we are comfortable deploying.”

With Fitzroy Place now done, McLeod and his team are getting ready to take on their next batch of projects, most of which do fit the asset-enhancement strategy.

Aviva has long owned multiple sites above or next door to Bond Street, Tottenham Court Road and Liverpool Street’s Crossrail station entrances, some of which are already under way and some of which will be started once the train line is complete – the central section is due to be operational by the end of 2018.

The largest project in the pipeline, albeit not one that will benefit from close proximity to a Crossrail station, is Fountain House at 130 Fenchurch Street, EC3, which the City recently approved.

The 17-storey block will provide about 350,000 sq ft of new office space when complete.

Vacant possession will not be achieved until next year and Aviva is likely to bring in a partner for a project of such scale before then, but it follows the model of extracting new value from a long-held asset instead of going out and buying City trophies.

Clearly the pipeline is well stocked, but is there still time to bring forward such major new schemes and catch the sweet spot in the cycle?

“The lower-yielding parts of the market are potentially more exposed when the market turns,” says McLeod. “But I do think London has consistently surprised on the upside. I am still very positive about it as an investment destination and also for the rental growth we definitely see coming through now And I think for now we are in a low-yielding environment generally. So while London looks expensive historically, so does Paris, so do big cities in Germany, so does fixed income.”

As a business, Aviva Investors is trying hard to readjust to that low-yielding environment at a time of huge internal and external change.

But Stirling, who oversees about £15bn of the group’s real estate assets across Europe, sees it as an opportunity.

“There was a lot of questioning for a while around whether Aviva was really committed to investment management,” he says.

Andrew Moss was ousted as chief executive of Aviva in the shareholder spring of 2012 as the group’s share price dragged along the floor, with the City questioning its sprawling strategy and precarious finances.

A period of huge upheaval followed, with executive chairman John McFarlane drafted in to fill the role until the arrival of new chief executive Mark Wilson at the start of 2013.

A strategic review of the business was undertaken, with entire divisions sold off or shut down.

Among the questions asked was whether investment management would be outsourced, Stirling says. “But to his credit Mark Wilson has been very clear from the beginning that we are committed to investment management and he is now investing heavily in the business.”

A central part of Wilson’s new vision has been to create easy-to-understand, “outcome-oriented” products for retail and institutional investors.

Broadly that has meant developing funds that aim to provide clear capital or income growth through exposure to property, something Stirling believes has proved to be “very clever”, given the huge changes that have swept the pension fund landscape, allowing retirees to make their own decisions about how to invest instead of requiring them to buy an annuity.

“A UK insurance company, coming to terms with the changes, needs investment management,” he says. “It is a massive opportunity for us to make sure that we have the right investment opportunities for people to invest in when they come to retirement with the new-found freedom that they have. An outcome-oriented fund that is looking to deliver a 5% income is something that would make a lot of sense for someone with freedom to invest their pension.”

Arguably, it is the annuity changes – their announcement prompted a 10% drop in the Friends Life share price – that helped bring another huge change for Aviva: a soon-to-be-signed-off mega-merger, a deal that will add significant funds under management for Aviva Investors.

But Stirling believes the rule changes will bring even greater opportunities for Aviva Investors and its particular brand of development-friendly fund management.

“One of the things we are looking at quite hard is residential. Because when the news was announced a lot of people were saying, ‘I will invest it in property because that’s what I understand.’

“Aviva is a large pension provider, so we have a relationship with pensioners and if we can create something that we can put to those people that would give them exposure to residential property – but give it to them in scale, with diversity, with professional management – I think it is a very interesting opportunity.”