Many LGPS investors seem willing to heed his call. Improved funding ratios combined with a desire for income are driving growing demand for housing strategies. In recent months, Border to Coast, ACCESS and LGPS Central have all confirmed significant expansions of their real estate offering.
Meanwhile, LPPI and London CIV have joined forces this year to launch the London Fund, which alongside infrastructure also invests in affordable housing. Aoifinn Devitt, recently appointed CIO at London CIV, joined Dowdall and Hughes on the Housing151 panel to discuss the opportunities for investing in local housing. London CIV, the pool for 32 local authority funds in London, is also currently on the lookout for managers for a new real estate strategy to meet growing demand from partner funds.
But the case for local impact investment is often easier to make in the capital than in other parts of the country, argues Matthew Trebilcock, head of pensions at Gloucestershire Pension Fund.
Outside of the UK’s property investment hot spots, it can sometimes take quite a bit of effort to make the case for local impact projects. “One of the biggest challenges we had is that conflict of interest with the manager around the localism aspect, it wasn’t in the eyes of many managers that Gloucestershire exists. Once we put the spotlight on that, a lot of very positive noises were coming out,” he stresses.
Another potential challenge is sourcing affordable homes, emphasises Dowdall. “The key issue that we face is this massive market failure where it is actually impossible to buy existing stock or buy new stock at rates that people can afford,” he argues.
One measure of affordability which GMPF uses is the salary of 1.5 ambulance drivers, who would rent a three bedroom semi around £1,200 a month. But in the greater Manchester area, only eight properties meet these criteria and all of these offer sub-standard housing, Dowdall explains.
Navigating demand shocks: lessons from Covid
While this acute shortage of affordable housing should mean that there is in theory unlimited supply, institutional investors should be mindful of unforeseen demand shocks impacting liquidity, as the Covid crisis illustrated.
Academic research on the role of patient capital in the provision in housing points out that the increased role of private finance in this provision means that the private rental sector has flourished.
While most risk assessments consider house prices to be stable due to the gap in housing supply, relatively little attention has been paid to demand crises, as Frances Brill, research fellow in geography at the University of Cambridge; Mike Raco, professor of urban governance and development at UCL; and Callum Ward, post-doctoral fellow at UCL, point out in a recent paper for European Urban and Regional Studies.
Having reviewed some 100 asset owners invested in PRC in London, they highlight how many pension funds were suddenly met with liquidity problems when rental incomes in London collapsed by more than 18% within just a few months due to the Covid pandemic.
Research shows that institutional investors were able to navigate these challenges by adjusting payment plans and increasingly focus on the provision of housing to key workers. Nevertheless, the researchers argue that in order for patient capital to remain patient in the face of economic certainty, more long-term oriented policy guidance and regulation is required.
An (almost) perfect match?
Despite these challenges, pension fund investors like Dowdall continue to see housing as a suitable match to their liabilities. But with bond markets offering above inflation returns, why should pension funds be allocating to highly illiquid assets such as bricks and mortar?
While many corporate defined benefit schemes have turned to UK Index Linked Gilts, Dowdall argues that real estate in fact offers a far better match to meet LGPS liabilities. “Index linked gilts are an excellent matching asset class for pension funds. Investment in residential property can, subject to successful execution, provide cashflows with a similar profile to index linked gilts, giving long term inflation linked cashflows,” he explains.
While real estate does not match inflation as precisely as Linkers, it offers better risk-adjusted returns, a crucial factor for open DB schemes whose liabilities are linked to inflation, he argues.
Indeed, the yield on Linkers is still too low to make them a suitable liability hedge for the LGPS, he says: “The low yield on index linked gilts means that if an LGPS pension fund were to use them exclusively to fund future liabilities the employer contributions would have to be in excess of 40%. Clearly a diversified portfolio is more appropriate for an open defined benefit pension scheme and therefore residential housing can play a part in that.”
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