Extensive property portfolios are synonymous with the wealthy, but how do private banks integrate real estate into the investment propositions for their clients? John Schaffer speaks with real estate experts in the industry to access HNWI demand for this asset class
Alternatives such as real estate have become more integral in high net worth (HNW) portfolios amidst a relentless low interest rate environment. Real estate is not merely the preserve of UHNWIs – funds and real estate investment trusts (REITs) often have achievable entry requirements. However, the big ticket direct investments require large capital investments and have a significantly larger illiquidity factor. Thus, real estate is an asset class where there is a notable disparity between different wealth bands.
According to Verdict Financial’s data, real estate accounted for 11.4% of global HNWI portfolios in 2015, indicating a strong interest in the asset class.
Demand for direct investments
Pol Tansens, head of real estate investment strategy and Claire Roborel de Climens, global head of private and alternative Investments at BNP Paribas Wealth Management tell PBI that there is strong global demand for direct real estate investment amongst the Bank’s client base:
“HNWIs are increasingly interested in direct real estate, many acquisitions being cross-border transactions. For example, Asian investors and buyers from the Middle East have always been attracted to London’s commercial (and residential) real estate. Evidently, European buyers are active as well, be it for domestic or cross-border dealings.
“However, after the Brexit vote, demand is progressively oriented towards assets located in Continental Europe. In particular Paris and a number of German cities appear to be popular.”
The Brexit effect
Evidently, the Brexit vote on 23 June 2016 sent jitters through the UK real estate market – with commercial property funds being temporarily closed in the aftermath, despite London traditionally being a hotspot for property investment.
Charles Boulton, managing director at HSBC Private Bank, says that property is particularly popular with UK investors:
“For the domestic UK market, real estate has always been a preferred asset class that, generally, investors see as a safe haven for wealth. They don’t see it as a volatile asset class and perhaps, sometimes overlook the risks associated with real estate investing.”
However, Delyth Richards, head of investment solutions at Kleinwort Hambros, suggests that client demand for UK commercial property could take a hit due to Brexit.
“The number of commercial tenants may be hesitating in making commercial lettings decisions at this point. It’s been quite widely reported that we don't quite know what the aftermath of Brexit truly is going to be from an occupational perspective.
“That creates some opportunities for investors but it also creates some clouds of clarity to determine whether you really wish to invest in a long term lease where you don't know what the tenant demand is likely to be. That's particularly going to affect the London office market. That's much less likely to impact an industrial distribution warehouse in the south east or the north of England, which is more based on domestic demand.”
Jon Wingent, head of portfolio specialists at Lloyds Private Bank, says that amongst UK domestic clients, demand for UK luxury residential property has also dipped due to changes in residential stamp duty. He tells PBI:
“It’s driven up prices at the lower end of the residential market as HNWIs have an increased appetite for building property portfolios”.
Wingent adds that post Brexit, there has been an increased demand for direct real estate investments from ex-pat clients:
“There was a pickup in demand amongst UK ex-pats who are denominated in dollars even prior to Brexit. The weakness of Sterling post Brexit has significantly increased demand.”
Private banking clients have always been associated with their preferences towards residential property. Owning property is one of the oldest expressions of wealth, and recently has been associated with being somewhat of a safe haven asset class.
Jansens and Roborel de Climens, BNP Paribas, tell PBI that there are often cultural factors that dictate clients’ approach to real estate investment:
“When analysing investment appetite, we are of the opinion that demand for residential real estate may be driven partly on a cultural element as well. This is certainly true for buyers from Asia and the Middle East who have always made acquisitions that may last for a generation or two. Another cultural key factor could be the use of debt to finance real estate. Some investors shun debt, while others use a maximum of borrowings. Also, not all mortgage markets are developed in the same way across the world.
“The same could be said of commercial real estate. HNW investors who buy a prime office or another trophy asset in London or Paris could consider their acquisition as a long-term investment carrying a reasonable cash yield, with capital return perspectives. For example, our French clients are also interested in acquiring commercial buildings with a view to building a legacy for their children. That’s why prime investments are still in high demand. Obviously, other investors have a more economic investment rationale, and make investments with the view to disposing of them after a couple of years after having made a reasonable capital gain.”
The trend of private banks allocating towards alternatives has flourished in recent years. Boulton, HSBC, tells PBI how yields can, in some instances, be attractive:
“Over the last year or so, because of the interest rate environment and low yields available from more traditional investments, we have seen an increase in people using real estate as a way of increasing yields on portfolios. In some of the deals we have done, you can achieve a 6%-7% yield – that’s a difficult thing to beat in listed investments.”
However the average HSBC allocation to real estate is fairly modest. Boulton says that the typical HNW allocation to alternatives stands at approximately 15% – with 10% in private equity and hedge funds and 5% in real estate. He adds that from a diversification perspective, most private banking clients are forced to keep their real estate investments in funds as they do not have the capital requirement to do otherwise.
However, not all institutions are advocates of real estate investment. Richards, Kleinwort Hambros, tells PBI that the bank has shifted its allocation away from real estate:
“From our core asset allocation perspective, we recommended selling out of real estate last year. From our core conviction we had invested in UK direct real estate on the basis of capital growth and diversification, we made a call to sell that position last March and we re-invested the proceeds from that alternative allocation into commodities. It was ahead of the outflows from the retail funds and we’ve managed to benefit from the commodities prices since that point.
“From the UK perspective, there’s a much more muted outlook for capital growth in the commercial sector. Given the low anticipated capital growth factors, we continue to have a negative short term view on direct real estate. However, from a REITs perspective, global REITs performed well last year, and over the last three years for sterling based investors. By contrast, had you been a USD client investing in a global REIT portfolio, the performance would have been more modest.”
Gavin Rankin, head of managed investments at Citi Private Bank, says that one of the attractive features of real estate investment for UHNWIs is how the asset class can achieve yield where fixed income securities are faltering. He tells PBI:
“One of the big trends blowing up amongst investors is this desire for yield. Yield will play a major degree in real estate returns. Conservatively managed properties with not significant leverage ratios, but are providing an attractive return are compelling investment opportunities in this broadly low yield environment.
“I can’t see the move away from real estate really happening, short of some significant economic change that we don’t see in the market at the moment.”
However, Rankin adds that although there hasn’t been a notable change in demand for real estate amongst Citi’s ultra wealthy clientele, there has been a dip in yield performance:
“The return profile has changed. The yields that you are getting in property today are different from what they were three to five years ago.
“In terms of the products that we’ve distributed, there’s been more of an appetite for real estate debt than there has been earlier in the cycle, we’ve seen an appetite for mezzanine financing on commercial property.”
According to Verdict Financial’s data, the yield experienced from rental income has also acted as a motivator for HNW investors. Verdict Financial’s Global Wealth Managers Survey indicates that rental income was a driver for 33.2% of HNW investors.
The Ultra club
Ultra wealthy private banking clients have a markedly different approach to real estate investment. They have the capital available to invest in direct investments as well as being able to stomach the illiquidity constraints.
Boulton, HSBC, tells PBI: “UHNW clients will always have an exposure to real estate because historically it’s been a pretty solid asset class. We have far more clients who see it as a favorable asset class than don’t, and the higher up the food chain you go in terms of client size, the more they can afford to tie up liquidity.”
Alongside the indirect real estate funds that HSBC provides access for its HNW clients, the bank also sets up club deals which involve multiple ultra wealthy clients investing in a direct real estate proposition in conjunction with third party asset managers, with an entry level of approximately £1m. The bank also sets up bespoke property portfolios for individual UHNWIs with a typical investment level of between £50-100m.
Citi Private Bank also has an ultra wealthy focus to its real estate offerings. Rankin, Citi tells PBI about the bank’s offerings which include funds, co-investments, club structures and direct investments:
“The foundation of our real estate offering is broad based funds. We identify an investment opportunity, look at the universe of managers who are raising capital and do our due diligence. We then partner with that manager and offer that fund to our clients. Typically you are taking that investment strategy, you are not taking specific investments yet, you're taking a fund in that investment mandate associated with a fund.
”Those vehicles are six to eight years in terms of life. Clients make a commitment at the outset and they're drawn down on that commitment as and when investments are made. We offer them globally, so we have opportunities in the US, Asia, and Europe. We also offer club structures for our more sophisticated clients, which will typically be made up of 50 clients worldwide. Clients sign up as a member of a club for three to four years and they see deal flow over that time – typically 10-12 transactions. They are required to do their own due diligence on each individual transaction and make a decision on each investment. Ideally they do all, but that’s not necessarily required.”
REITs on the rise – but not so much for UHNWIs
Real estate investment trusts (REITs) have grown in popularity amongst HNW investors. Verdict Financial’s data indicates that REITs make up the largest portion of allocation to real estate in the average HNW portfolio.
Jansens and Roborel de Climens, BNP Paribas, suggest demand has been buoyant for REITs amongst the bank’s clients:
“REITs carrying an attractive dividend yield were popular last year, given the almost zero-rate interest rate environment. Asian REITs performed well, by 16% on average in the year ending on 9 January 2017, and in spite of a huge disparity in returns between Asian countries. Somewhat surprisingly, and in spite of higher nominal interest rates, North America REITs also performed very well in the same period. Continental Europe and Japan booked total returns between a respectable 6% and 10% whereas the UK was the only region posting a negative return of about 5% in a weakening pound.”
However Rankin, Citi, tells PBI that REITs are less popular amongst UHNW clients:
“Typically the clients that we're dealing with are taking more direct or fund based exposure – so REITs are not a big part of what we do.”