Smaller funds tired of carrying the weight of property investments

The current sale by the Construction Federation Executive Pension Fund of its portfolio of five commercial properties is part of a trend among the smaller pension funds to sell off their property holdings and put the proceeds into larger funds, according to people in the fund management business.

"There certainly is a trend in this direction both here and in the UK over the past number of years," according to John Bruder, Head of Property with AIB Investment Managers. "The more sophisticated and complicated the property scene becomes, the less attractive it is for relatively smaller operators because it is quite a commitment and a burden to do it properly."

There are quite a number of smaller pension funds around, mostly based on older and well-established industries or sectors of the economy. Most of them have direct holdings of commercial, industrial and retail property but the proportion of their overall funds invested in property has been declining in recent decades.

In the 1970s, the average pension fund had about 15 per cent of its money tied up in property: now the average is about half of that. The funds have not necessarily been selling property over the years but the property part of their portfolios have not been increasing relative to the other parts of their portfolios, notably equities.

As a result, a £100 million pension fund - representing a reasonably sized company in Irish terms - might have £7 million to £10 million in direct property holdings. That amount would not buy anything approaching a balanced property portfolio in today's market.

"You might buy one office building with it or two shops or three warehouses but not all those together," according to Sean O'Brien, property investment manager with Irish Life. "Lot sizes now are quite large and to buy a 40,000 sq ft office block, you're talking £10 million."

The argument in favour of smaller funds moving into larger property funds is quite simple. Industry figures suggest that if you have one property, then half of your rental income is decided by the overall market and half by factors affecting the specific property such as its location, condition and tenants.

Unlike individual investors who may want to beat the market with a handful of holdings, pension fund trustees are not people who generally want surprises. Most would be happy to mirror the market's long-term returns. The more properties you have, the less the return is dependent on individual buildings and the more likely it is to move in line with overall market returns.

It is generally accepted that the minimum holding necessary for a diversified property portfolio is about 10 properties. In today's market, depending on the size of the properties, that would cost between £20 million and £50 million - which would mean that many smaller pension funds should probably increase their property holdings.

However, the easier option for some is the route being taken by the Construction Federation Executive Pension Fund which is to sell its buildings and put the proceeds back into one of the large specialist, tax-exempt property funds such as those run by Irish Life (which has a £300 million property portfolio) and AIB (a £150 million portfolio).

"If a pension fund wants an exposure to the market as opposed to an exposure to one or two buildings, which can behave differently to the market, then it makes an awful lot of sense for them to go into a vehicle and pool their resources with other investors so that they actually get a balanced exposure to a range of commercial property," says Sean O'Brien of Irish Life.

The larger funds point to the other advantages for smaller funds, apart from diversification, such as not having the responsibilities of direct ownership. They do not have to collect rents, examine and repair buildings, arrange valuations, and ensure that they are adhering to all aspects of landlord and tenant laws. On the other hand, of course, the larger funds will take their commissions out of the smaller funds' investments with them.

Suggestions that the Construction Federation pension fund's move is an indicator that the commercial market has peaked will only be proven or disproven by time. In spite of the trend seen by the larger fund managers, there is no race out of commercial property at present: indeed, the main feature of the market in recent months has been the entry into it of individual investors and small consortiums.

John Bruder of AIB remains confident that the market is still strong. "I would argue that by any objective measures, despite the good growth it has had for the last couple of years, property remains modestly valued by reference to the other markets. It's still possible to buy property yielding you 6 per cent or 7 per cent and even 8 per cent with very good growth capital appreciation prospects over and above that."