Alternatives: a small label that covers a myriad of assets that are increasingly finding themselves part of the real estate asset class arena.
The term “alternative” typically means an alternative to core asset classes, so, in fact, property as a whole is viewed as an alternative by many institutional investors, who typically allocate the vast majority of their capital to equities and bonds (approximately 90% in total). However, when you consider property in isolation, alternatives are anything that is not retail, office or industrial.
Alternative real estate covers a number of sectors, which can be very different from each other. For example, private rented residential, primary healthcare and rural land offer totally different performance characteristics. It is therefore slightly misleading to talk about alternative real estate as an asset class in its own right as it is more a banner which represents a wide array of sectors, all with different drivers of performance, market cycles and characteristics.
Looking back over recent MSCI alternative sector indexes, it is clear that investors with these kinds of holdings have been reaping the benefits when compared with traditional and core real estate asset classes.
In 2014, the IPD UK Annual Forestry Index showed a total return of 18.4% for the year, an increase from the 14.9% seen in 2013 and continuing the trend for very strong performance by forestry investment in the UK. The three-year annualised total return of 17.3% is almost double the 8.9% annualised total return achieved since the first IPD index was launched 22 years ago.
By its very nature forestry investment represents a long-term capital play, with no source of regular income unless holdings are leased for renewable energy production. However, part of the capital return is achieved by harvesting timber once trees reach maturity, meaning investors receive irregular but substantial sales receipts which complement long-term growth in the underlying value of land.
From the late 2000s the incentives to use wood for energy have helped push timber prices to new levels. Land-based assets have also provided an alternative home for cash deposits in times of low interest rates and for investors seeking less volatile markets.
Rural land as a whole has also continued to outperform, returning 10.2% in 2014, according to the IPD UK Annual Rural Index, and 12.5% pa over the past 20 years.
We have just experienced a 20-year period of continuous land price growth and, in the case of UK forests, returns have rocketed. The limited supply means that UK land is seen as a relatively safe place to deposit money, particularly in forestry, which has additional tax benefits.
Hedging against economic downturns by investing in sectors where the drivers of price and rental returns are not as closely linked to the underlying performance of the economy, as is the case for shares and commercial property, is a key driver for investment in alternatives. There will always be demand for healthcare and housing, so these sectors offer far greater protection from economic downturns and occupier defaults if businesses are not performing well.
Investors are seeking asset classes that offer long-term, secure income returns linked to inflation and possibly even backed by the government, as is the case with UK primary healthcare. Student accommodation is also popular for this reason, though these assets lack the security of long leases. MSCI analysis shows that private rented housing offers secure income but at relatively low yields. Investors need to find assets that meet their long-term liabilities and these sectors offer high enough yield and income security to do this, without the risks to capital associated with core commercial property.
Our analysis shows that alternative sectors are far less volatile than core commercial property and equities in particular. They also tend to enjoy growth in real capital value over time, particularly for residential and land assets, so investors’ capital is far better protected from downturns and the risk of becoming a forced seller at the wrong time in the market cycle.
Most importantly for asset owners and managers, alternatives significantly outperform commercial property and core asset classes in terms of total return. Certainly this is the case for UK residential and land assets due to their high levels of capital growth. Commercial property loses its value in real terms in the long run; alternatives don’t.
Not a bad unique selling point for a “property” sector that doesn’t quite fit in the box.
Phil Tily is executive director of MSCI
