Real Estate: An Alternative
Legal & General, the world's largest pension fund, is set to generate a ￡600m profit from its alternative assets division by 2025. The division has made a committed effort to invest heavily in alternative real estate assets, such as finance for small and medium-sized firms, specialized commercial real estate, digital infrastructure, and sustainable energy, committing ￡5bn of capital in 2022. Complimentarily, The Crown Estate reported earnings increase of ￡129.9m in its latest fiscal year, the rise mainly attributed to income from its alternative real assets business – option fees from offshore wind farm licenses – not its hallowed central London real estate. The success in alternatives partially compensated a fall in the portfolio's overall value. The value of regional assets decreased by 11.8% to ￡1.5bn in the year to the end of March. London assets also fell 6.5% to ￡7.2bn. Alternative investment strategies, according to Goldman Sachs, can provide access to differentiated sources of return, which can be broadly catalogued in two categories: alternative beta factors – for instance, since U.S. REITs became a component of the S&P 500 Index, they have had a correlation of 0.70 to that index, double their pre-inclusion correlation of 0.36, suggesting that a meaningful idiosyncratic risk and return component has been subsumed by the market dynamics of managers with broad public equity mandates - coupled with alpha from manager skill. As such, according to S&P Global Ratings, alternative asset managers have seen good investment returns, while average fund sizes have grown and platforms have broadened.
The transition towards alternatives will change the skillsets required for real estate professionals and require organisations to compete with other industries to attract data-savvy young talent, according to Byron Heffer of Ferguson Partners. To attract and retain personnel, organisations will not only need to offer competitive pay but also build diverse talent pipelines that include individuals with backgrounds outside of traditional real estate. Adaptation is critical. According to the Boston Consulting Group, asset managers need to embrace change in order to achieve profitable growth. Maintaining the status quo would result in yearly profit growth of roughly half that of the recent industry average (5% versus 10%). They calculate that to return to historical levels of profitability, asset managers should reduce costs by 20% and adjust their revenue mix to include at least 30% from higher-margin products, particularly Private Markets which represent $20 trillion of global AuM as of year-end 2022 and accounted for half of the industry’s global revenues, generating more than $190bn in revenues for the firms that offer them. This strong momentum is expected to prevail with a CAGR of 7% in alternative assets over the next five years.
In line with this trend, the Korean Investment Corporation plan to allocate 25% of AuM to alternative investments by 2025 instead of 2027 as it had originally intended. Incidentally its real assets division notched 7.6% return in 2022 whilst the find returned a -14.4% return. AXA Investment Managers is also restructuring its alternatives business and creating a €188bn alternative investments arm. The new arm will focus on real estate, infrastructure, natural capital, impact investing, alternative credit, and hedge funds. This move aims to prepare for future growth and provide a clearer structure for clients. Similarly, the National Pension Service of Korea is also increasing its exposure to alternative assets. The investor has added Bridge Industrial, a US real estate company, and investment bank Goldman Sachs to its list of international real estate investment managers. The pension fund plans to allocate 15% of its portfolio to alternative assets, as stated in its Q1 statement. Likewise, Sweden's AP7 aims to diversify its investment holdings by increasing its holdings in alternative assets to approximately 20% of its total assets. CEO Richard Gr?ttheim announced at a conference that the pension fund will increase allocations to private equity, target an 8% allocation to real estate, and allocate 2-3% to infrastructure. Gr?ttheim emphasized the importance of transparency and openness in the complex field of alternative investing.
The nature of alternative assets is characterized by unpredictability, as consumer requirements and trends can shift rapidly. Take two popular alternative investment strategies, and compare the macro landscape from 2021 to date: groceries, and its derivative real estate such as dark kitchens, and vertical farming.
The grocery shopping landscape has undergone a significant transformation since the pandemic, with customers spending more on own-label products, reducing store visits, and relying on loyalty programs for discounts. Rising food prices and the cost-of-living crisis have contributed to these changes. Kantar's data indicates a decrease in internet food purchases in the UK from a peak of 15.4% in February 2021 to around 12% at present. Business models aimed at disrupting sector can require rapid adjustments. In the food delivery sector, Just Eat Takeaway is transitioning back to the gig economy model and terminating 1,700 delivery couriers across the UK. The company had previously employed these couriers as part of its "Scoober" model, which was launched in late 2020. The majority of the operations team associated with the model will also be laid off.
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Despite earlier expectations of transforming agriculture, indoor farming has struggled financially. AeroFarms, a New Jersey-based vertical farming company, has faced financial difficulties since its failed attempt to go public in 2021. Other vertical farming companies have also encountered challenges, with some shutting down or scaling back operations. AppHarvest, which went public in 2021, is warning of potential financial difficulties by October this year. The uncertain economic conditions and high start-up costs have made investors cautious in this sector.
The competition between the US and Europe for battery manufacturing components, is pushing industrial and environmental policy into geo-politics. Northvolt, a player in the battery market led by a former Tesla executive, is being offered hundreds ofms of euros by European authorities to build plants in Europe. However, Northvolt had considered investing in the US instead, given the current desirability of the American market. Volkswagen (VW) has announced plans to construct its first battery plant in North America, specifically in Canada. This decision is part of VW's growth strategy in the region, which has been accelerated by US President Joe Biden's green incentives. VW had previously postponed its planned battery plant in eastern Europe, awaiting the European Union's response to US subsidies. Although VW remains committed to battery production in Europe, there may be a reduction in the number of planned plants. Tata Motors, the owner of Jaguar Land Rover (JLR), is seeking over ￡500m in government aid to establish a new battery factory in the UK. The company is considering locations in Spain and southwest England for the plant and has given UK ministers a few weeks to provide financial support. This decision is critical for the future of the UK car industry as it determines the level of support for the transition to electric vehicles.
Despite the huge government support, some businesses seem to be struggling. Cornish Lithium, a UK lithium project developer, is in need of a ￡10m capital injection by the end of the month to avoid insolvency. The company aims to produce battery metal in Cornwall. While the US and EU are prioritizing the security of essential mineral supplies due to Russia's invasion of Ukraine, the UK is struggling to attract investors for battery manufacturers.
There is clearly and justifiably a refocus to alternative asset classes, which allows firms to reorientate their portfolios, adds diversification and the potential to generate investment alpha. Monarch Alternative Capital LP, a prominent investment firm with about $11bn in assets under management with a strong real estate focus, announced the creation of Go Outdoors, a platform for the acquisition, development, and management of marinas and RV resorts across the United States. As a counterbalance, one of Britain’s most illustrious real estate investors, Delancey, stated that it has sold 17 of the 20 schools owned and run by Alpha Plus Group. In 2007, Delancey bought the business in an unusual deal for a fund manager of commercial real estate. The portfolio of freehold properties controlled by Alpha Plus in London at the end of the previous year was valued at ￡145m. By operating more schools, which would result in more students, and by boosting the tuition that students must pay, the agreement sought to increase revenue. Alpha Plus's enrollment and top-line revenue increased while Delancey was in charge, but this rise did not lead to a profit however. A ubiquitous market theme, with an estimated market worth of $200bn in the U.S., has become industrial outdoor storage (“IOS”), a new property type created as a result of rising expenses for conventional industrial buildings, is quickly becoming a favourite of more opportunistic commercial real estate investors.
However alternative investment strategies, like IOS, whilst technically sound, are often impractical to implement. Investment opportunities could be limited in scope, profits long dated and technical resources unavailable or underwhelming. We like to think of alternative real estate strategies in the same way Bill Ackman, the head of one of the world's largest hedge funds, thought of his investment in Bremont, a luxury British watchmaker. After buying a number of the company's watches at the company's Mayfair shop in London, he got in touch with the English brothers and wrote a handwritten email to the creators saying, "I appreciate your company, I love watches, and I would love to learn more." Amidst the challenges and intricacies of ‘alternatives’ and the demise of the ‘traditional’, the allure of untapped potential, and political objectives will serve as catalysts for growth. As alternatives come with greater volatility, investors should continuously adapt their strategies, akin to the Japanese philosophy of Kaizen, the practice of making small, incremental changes over time rather than large-scale, dramatic shifts all at once.?