phd masterclass eres 2012 (1)
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SWIP/ REAL ESTATE INVESTMENT
Dr Edward Trevillion
PhD Masterclass ERES
14th June 2012
Professionalclient use only not for retail clients.
This document is intended only for the person to whom it has been delivered and may not be forwarded to a third party without prior consent fromScottish Widows Investment Partnership. Any investment decision should be based on the information contained in the appropriate Prospectus whichshould be read prior to investing.
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Agenda
Fund sizes (SWIP) and trends
SWIPs research team
Property as an asset class
The global real estate market
The investment decision process
The SWIP forecasting process
Risk
Conclusions
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Scottish Widows Investment Partnership is one
of Europes largest investment companies1
andthe centre of investment managementexcellence for the Lloyds Banking Group
Based in Edinburgh we employ 506 colleagues,including 168 of the investment industrys most
experienced specialists2, across 3 investmentlocations Edinburgh, London and New York
We specialise in high alpha equities, fixedincome, real estate and multi-asset. We alsooffer a number of specialist strategies, includingmoney-market, private-equity, multi-managerand absolute-return funds
SWIPs clients range from banks and insurance
companies through to private investorsworldwide
SWIP assets under management
Assets under management
142.32bn2
Source: 1IPE, June 2011. 2SWIP, 31 March 2012.
Pacific (Developed)
& Japanese Equity2.84bn
Cash
24.49bn
UK Equity
41.02bn
Sterling FixedIncome
39.20bn
Emerging Markets
Equity
1.66bn
North American
Equity
6.22bn European Equity
6.91bn
Real Estate8.67bn
Other Investments
2.97bn
Overseas Fixed
Income
8.36bn
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Geographical diversification in SWIP real estateportfolios (UK)
Geographical distributions December 2011
0%
5%
10%
15%
20%
25%
City
MidTown
WestEnd
InnerLondon
OuterLondon
SouthEast
SouthWest
Eastern
EastMidlands
WestMidlands
Yorkshireand
Humber
NorthWest
NorthEast
Scotland
Wales N
I
OffshoreUK
Other
%
CapitalValue
SWIP Annual Universe
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Changing fortunes of property in portfolios
Use of index linked bonds
Really hedge against inflation?
Better understanding of the real value oftotal returns from property, partly,because of the greater markettransparency resulting from the IPDindex.
The removal of exchange rate controls in1979 allowing institutions to achievegreater diversification overseas andreducing the importance of property as adiversifier.
Dividend controls were also removed atabout the same time allowing dividendson equities to be increased making thema more attractive investment medium.
But revisionist view that weights ought tobe increased (10-15%?)
Fund property weightings as proportion of total AUM
0
5
10
15
20
25
30
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
%
L ife funds Pension funds
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SWIPs Research team
Research is fundamental to SWIPs investment style and philosophy
Highly respected research team of six professionals
Undertakes a range of work to underpin investment decisions and identify new areas forinvestment
Work includes
Market based analysis
Performance measurement and analysis
Risk measurement and analysis
Transaction support and longer term research
Key input from SWIPs economic team
Quarterly forecasts of future property performance for both the UK and Europe Input into every investment proposal and also coordinate a bottom up review of the
market and market risks which complement our top down strategic market reviews
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Property as an asset class
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Property as an asset class
Real estate remains a good diversifier for portfolios dominated by equities and
bonds
Performs well relative to other investment categories (risk/return)
Secure and stable cash flow
Low volatility of returns
Property investments are rights over land and buildings
As a consequence are tangible and durable assets
Rent is a contractual obligation like interest on debt, dividends are not
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-6%
-4%
-2%
0%
2%4%
6%
8%
10%
12%
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
e
Income return Capital growth Total return
Secure and stable cash flow?
Source: IPD Multi National Index: May 2011 (historic figures) and SWIP/JLL, December 2011 (forecastfigures). Forecasts are opinion only, cannot be guaranteed and should not be relied upon when makinginvestment decisions.
European property returns
20
12f
20
13f
20
14f
20
15f
?
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Calm in a storm?
Source: IPD, Datastream, ECB, April 2011. The above is provided for illustration and discussion purposesonly.
A quiet summer for the property market despite the turmoil seen in other markets
Bond Yields and Asset Price Movements 2011 - 2012
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
4.5%
03-
Jan
31-
Jan
28-
Feb
28-
Mar
25-
Apr
23-
May
20-
Jun
18-
Jul
15-
Aug
12-
Sep
10-
Oct
07-
Nov
05-
Dec
02-
Jan
30-
Jan
27-
Feb
26-
Mar
Source: IPD, Datastream, ECB
60
70
80
90
100
110
120
130
140
150
UK 10 Yr Bond yield (LHS)Euro Area (AAA rated only) 10 Yr Bond Yields (LHS)IPD Capital value index (RHS)FTSE All Share price index (RHS)Dow Jones Euro Stoxx Index (RHS)
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The global real estate market in context
Source: World Federation of Exchanges, Bank of International Settlements, EPRA, Equity figure - November2011, Bond figure June 2011, Property figure - December 2010.
Property is a significant asset class
USD
TRILLIO
NS
Global market sizes
Global Fixed
Income
$99.55tr
Global Equities
$47.41tr
Global
Commercial
Property
$23.99tr
$0
$20
$40
$60
$80
$100
$120
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Diversification through global investment
Pros
Access to a larger universe ofproperties
Potential access to faster growingeconomies
Access to different sectors of the
property market and at differentstages of maturity
Cons
Currency risk
Lack of transparency and liquidity insome markets
Concerns over title/legal issues
More limited data
In times of crisis, investors return to domestic markets
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The global real estate market
Canada$16 bn
USA$169 bn
WesternEurope
$108 bn
UK$51 bn
Japan$29 bn
Central andEasternEurope$21 bn
China$231bn
Source: RCA, 4 January 2012. Transactions for 2011.
Toronto $6 bn
Vancouver $1 bn
New York $29 bn
Washington DC $16 bn
Boston $6 bn
London $28 bn
Paris $16 bn
Berlin $6 bn
Milan $2 bn
Frankfurt $5 bn
Istanbul $0.8 bn
Beijing $20 bn
Shanghai $26 bn
Hong Kong $20 bn
Tokyo $23 bn
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OECD forecasts for GDP
Forecast GDP (2012 14) % pa
Historic GDP (1988 07) % pa
Source: Oxford Economics, December 2011.
South Africa
3.8%
Brazil
4.0%
USA
2.5%
Canada
2.3%
UK
2.2%
Europe
1.4%
Russia
4.0%
Turkey
3.1%
India
7.9%
China
9.3% Japan
2.1%
Australia
3.4%
2.8%
3.0%
2.5%
2.3%
0.7%
4.1%
9.7%
6.4%
2.4%
2.6%
3.3%
2.0%
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Transparency of markets
Highly transparent Transparent Semi transparent
Australia Finland Greece
Canada Spain Slovakia
United Kingdom Austria Russia1
New Zealand Singapore Romania
Sweden Norway Taiwan
United States Hong Kong Chile
Ireland Portugal Turkey
France Switzerland Dubai
Netherlands Italy Brazil
Germany Poland Thailand
Belgium South Africa India1
Denmark Czech Republic South Korea
Malaysia China1
Japan MexicoHungary Ukraine
Israel Philippines
India
Argentina
Slovenia
Abu Dhabi
Source: JLL, June 2010. 1Tier 1 cities only.
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The investment decision process
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The decision and market cycles
Sources: 1. Morgan Stanley/SWIP.
Bottom
Early-Stage
Recovery
Mid-Stage
Bull Market
Peak of
Bull Market Bear MarketMarket Phase:
Exhaustion, disbelief& demoralisation
Doubt, reflection& conversion
Faith, hope& charity
Euphoria, greed& expectation
Fear, panic &loathingPsychology:
1
GeneralAsset Price
Moves
(Vertical)
Asset repricingBuying and sellingopportunities leadingto re-balancingportfolios
Buying opportunitiesand bargain huntingcan deliver futurecapital growth for theportfolios leading toenhanced returns
Seeking opportunities for
full value; employ selfdiscipline! Back to basics.Manage tenantsand concentrateon income as adriver for totalreturns. Minimiseoutflows, rates,liabilities
Asset repricingBuying and sellingopportunities leadingto re-balancingportfolios
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Capital investment decisions
IRR generally used in project decisions
Offers a convenient method for choosing from mutually exclusive projects when capital
rationing prevails. Comparison between alternatives is simplified by ranking projects according
to their rate of return
Popularity of IRR in part psychological: managers simply prefer a measure of investment worth
which is expressed in percentage terms.
However: not uncommon to find that the margin between a projects success or failure
hinges on the enthusiasm and commitment of the person sponsoring and implementing
it.
See also R. Pike and W. Neale Corporate Finance and Investment: Decision and Strategies. Prentice Hall
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Hurdle Rates as a decider of investment decisions
Errors on forecasts
Nature of property itself
No clearing price
Lumpy inefficient market
Rational pricing? Investor psychology
Asset characteristics?
Leases shortening affecting risk assessments
Dont want to tie into hurdle rates, which potentially have large errors and miss good
opportunities so.
Should one take an holistic approach using market forecasts and IRRs simply as aguideline placing significant emphasis on the investment managers bottom up approach
to individual assets.
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Specific deal considerations
Tenure? Covenants?
Property specific issues?
Market commentary
Occupational issues
Investment market specifics
Sector review conclusions house view positive/ negative/ neutral bottom up
Combine with research top down view positive/ negative/ neutral?
Research input
Fund issues weighting? Risk?
Financial analysis yield considerations; IRR; Valuations
Reasons for sale/ purchase
No specific hurdle rates
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The SWIP forecasting process
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SWIP Real Estate division: Investmentprocess
Rigorous, research-driven investmentapproach
Specialist active real estate expertise
Emphasis on strong research capabilitiesand experience
All asset identification and investmentdecisions driven by our research efforts:
Market based analysis
Performance measurement andanalysis
Risk analysis
Transaction support
Focus on fundamentals to formulate afund strategys business plan and informdecision making at the asset level
EconomicTeam
PropertyResearch
Team
Strategic Market Review
House View
Sector Review
PortfolioImplementation
PortfolioBusiness
Plan
Individual AssetBusiness Plan
Fund Strategy
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The forecasting process
SWIP TopLevelMacro
economicforecast
OxfordEconomics
UK and Segmentspecific forecasts foremployment and outputeconomic drivers
Combineeconomicdrivers
Rent andyieldpropertymodel
Cashflowmodel
Totalreturns,capitalgrowthandincome
returns
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SWIP Forecasting system
Covers 12 segments
Standard shop units
Shopping centres
Retail warehouses
City offices
West End offices
RoSE offices
RoUK offices
Business parks
SE industrials
RoUK industrials
Distribution warehouses
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The economic input
Shape of UK and regional economic output, employment, retail sales and Governmentbond yield forecasts stamp their mark on the shape of the property forecasts.
Other macro-economic factors such as interest (swap) rates and inflation impact on yieldforecasts but investor preference and the weight of money coming into property isclearly also important.
SWIP Top Level forecasts include:
UK Economic Output
Retail sales UK Manufacturing and services employment and output
Inflation
Interest rates
Gilt Yields
SWAP Rates
These ultimately drive UK and segment specific forecasts for employment and outputeconomic drivers
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Rent model model drivers
Driver 1 Driver 2
Standard shop units
Shopping centres
Retail warehouses
City offices
West End offices
Mid Town offices
RoSE offices
RoUK offices
Business Parks
SE Industrials
RoUK Industrials
Distribution Warehouses
UK Retail sales volume
UK Retail sales volume
UK RSV household goods
City F&BS employment
WE F&BS employment
MT F&BS employment
SE Service sector employment
UK F&BS employment
UK F&BS employment
SE Economic output (GVA)
UK Manufacturing output
UK Distribution output (GVA)
UK Retail sales Volume
Take-up and availability
Take-up and availability
Take-up and availability
City rental growth
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Equivalent yields
Yield forecasts bring together assessments of a number of components and drivers of
yield:
Swap rates
Long run ERV trends
Risk free rate
Risk premium
Rental growth
Inflation
Depreciation
Combined with a reversion parameter which dictates the extent to which yield forecastsare brought back to their long term fundamental value.
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A simulation model
Rents and yields feed into simulation model
Simulation model is effectively a cash flow model applied to the forecast IPD segments
Takes into account market void rates, lease lengths/renewals, degree of over-renting etcto produce estimates of:
Income returns
Total returns
Capital growth
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Main outputs
ERV growth
Equivalent yields
Capital growth
Income return
Total return
Addresses historic priorities but may change to more regionally specific markets
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Risk
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Real estate market riskA quick reminder
Specific risk is the variability in return due to factors unique to the investment
Can be diversified out and declines as the number of securities increases
Historically measured by standard deviation (volatility)
Systematic or market risk is the variability in return due to the dependence onfactors which influence the return on all securities to varying degrees
Portfolio diversification cannot provide protection against this form of risk
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Implied risk premium?
Can estimate the current degree of risk (or risk premium) being attached to
property by estimating the difference between property equivalent yields and arisk free rate
Simplistically
Where y = Property equivalent yield
b = Risk free rate
r = Risk premium
g = Future rental growth provision
y - b = r - g
Property yields against government bond
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Property yields against government bondyields
The perception of risk was low in 2007 but the reality was different
Is the risk premium now too high or correct in the current climate?
-3%
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
7%
2005
2005
2005
2005
2006
2006
2006
2006
2007
2007
2007
2007
2008
2008
2008
2008
2009
2009
2009
2009
2010
2010
2010
2010
2011
2011
2011
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3
Perceived Risk Premium - Office Actual Risk Premium - Office Prime office yield 10 year German bond yield
European property yields (ex UK & Moscow) vs German bond yields
Source: JLL, September 2011. The above is provided for illustration and discussion purposes only.
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Location risk
Location: An important diversification factor but different locations carry
different risks
We have attempted to quantify risk using more than just the volatility of returns
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Do I invest? Our approach
Ranking scores for each risk factor: lowest risk =1, highest risk = 10
Performance drivers Risk factors
Offices
Retail
Logistics
F&BS/PA output
Services confidence
Occupier demand
Supply
Consumer spending
Consumerconfidence
Retail spending
Occupier demand
Supply
Manufacturingoutput
Consumer spending
Accessibility
Occupier demand
Supply
Volatility of F&BS/PA output
Country 10 yr bond yield
Liquidity
Transparency
Volatility of total returns
Volatility of consumer spending
Country 10 yr bond yield Liquidity
Transparency
Volatility of total returns
Volatility of manufacturing output
Country 10 yr bond yield
Liquidity
Transparency
Volatility of total returns
Volatility of consumer spending
Citypreferences
The above is provided for illustration and discussion purposes only.
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Where are we in the cycle?
CapitalVa
lues
Growth StageEnd of CorrectionStable Declining
Berlin
Prague
Washington DCLisbon
Helsinki
Hamburg
Stockholm
Dublin
Barcelona
Athens
Madrid
AmsterdamHong KongMilan
Paris
Frankfurt
Dusseldorf
Munich
Warsaw
London Toronto
Beijing
NYC
Source: SWIP/JLL/RCA, Q4 2011 outside Europe. European data as at Q1 2012. All data for offices
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The indifference curve - Observations
Risk is more than just about volatility of total returns
SWIPs approach looks at the drivers of property returns and how these can
be used to rank locations in terms of risk
The example for offices shows that:
Forecast returns for Athens well below those required for the given level of risk
Warsaw, Toronto, Shanghai and Prague offering higher returns for their risk profile
This approach is being used by SWIP in determining the appropriateinvestment for our European unit shops strategy
Location offers opportunities because the evidence is that the global real
estate cycle is not synchronous (although it may become so in the future)
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Conclusions
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What does this mean for property?
Lower returns, driven by income
Lower appetite for risk (eg less speculative development)
Lending remains restricted
Caution prevails (consumers and businesses)
Prime property holds up, secondary weakens
BUT location opportunities reflecting local economies and property markets
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So opportunities in a world of uncertainty?
Commercial property still looks good as an asset class going forward
Real estate still sits in the middle of the risk return spectrum of all assets
Clearly risk and how we mitigate risk needs to be addressed with some urgency in thepresent economic climate
Sectors are not the key issue at the moment. In the current climate of uncertainty thequality of assets and markets is more important
Depending on the location and local economy stock selection can offer:
A secure/stable cash flow in uncertain times OR
Opportunistic investment in stronger economic and market conditions
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So opportunities in a world of uncertainty?
Commercial property still looks good as an asset class going forward
Real estate still sits in the middle of the risk return spectrum of all assets
Clearly risk and how we mitigate risk needs to be addressed with some urgency in thepresent economic climate
Sectors are not the key issue at the moment. In the current climate of uncertainty thequality of assets and markets is more important
Depending on the location and local economy stock selection can offer:
A secure/stable cash flow in uncertain times OR
Opportunistic investment in stronger economic and market conditions
Is bond type property now more appropriate at this stage for the mature markets of theUK, US and Mainland Europe where huge economic uncertainties remain?
BUT granularities in market and stock will always offer opportunities to beat forecasttrends
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Important information
Professional client use only not for retail clients.
The information contained in this document has been derived from sources which we consider to be reasonable & appropriate. It may also includeour views & expectations, which cannot be taken as fact. This information is supplied to you in confidence & you may not pass it on to any otherparty without prior written consent.
The value of investment is not guaranteed and can go down as well as up depending on investment performance. Past performance is not a guide tofuture performance. Furthermore, for non-sterling denominated investments, currency movements may cause an additional favourable orunfavourable change in value. Due to the above factors, investors may not receive back the full amount originally invested.
Investment markets and conditions can change rapidly and as such the views expressed should not be taken as statements of fact, nor relied uponwhen making investment decisions. Smaller companies may be less well established and carry a higher degree of risk than larger companies.
Forecasts are opinion only, cannot be guaranteed and should not be relied upon when making investment decisions.
Funds under management are an internal estimate.
Scottish Widows Investment Partnership33 Old Broad StreetLondonEC2N 1HZPhone: +44 (0) 20 7203 3000Fax: +44 (0) 20 7203 3289
swip.com
Scottish Widows Investment Partnership Limited (SWIP) is registered in England and Wales, Company No. 794936. Registered Office is at 33 OldBroad Street, London EC2N 1HZ, UK. Tel: +44 (0)131 655 8500. SWIP is authorised and regulated in the UK by the Financial Serv ices Authority andis entered on their register under number 193707 (www.fsa.gov.uk). Calls may be recorded and monitored to help improve customer service and fortraining purposes.
http://www.fsa.gov.uk/http://www.fsa.gov.uk/