PhD Masterclass ERES 2012 (1)

8/12/2019 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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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



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 manufacturing output

Country 10 yr bond yield

Liquidity

Transparency


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/

PhD Masterclass ERES 2012 (1)

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