The Appeal of UK Core Long-Income Commercial Real Estate Investing: An Attractive Alternative to Traditional Liability Matching

The UK investor has few choices to deliver income that can meet their long-term needs. Despite having less liquidity, private markets, and more specifically real estate, might be the best answer.

Defined Benefit (“DB”) Pension Schemes in the UK have traditionally sought to generate required levels of  investment return via investing across a balanced strategy, including conventional liquid investments such as bonds and equities, together with more illiquid alternative assets such as real estate, private equity and infrastructure. As DB schemes move towards maturity, the need to de-risk typically skews investment portfolios towards the security and certainty of fixed income. At the same time, reducing inflows increase trustee focus on liquidity.

Asset value deflation, initially post-Global Financial Crisis (“GFC”) and more recently due to the global Coronavirus pandemic, has led to extended periods of Quantitative Easing and a flight to safety and defensive investing. This has pushed bond yields to historic lows and large numbers of mature DB schemes into deficit; a dynamic that has been exacerbated by an ageing population across major western economies, with DB schemes required to support more retirees for longer. This so-called pension ‘timebomb’ is starting to tick loudly for a number of mature DB schemes.

So, how can UK commercial real estate provide a solution to what is becoming one of the defining problems of our time?

One answer is via a well-structured, well-executed long-income strategy, enabling schemes to achieve stable and dependable index-linked liability matching over periods of 20+ years, whilst also providing longer term distributable income returns of up to 4.0% per annum. At a period in the cycle where comparable duration gilts provide sub 1.5%, this can offer real appeal and a welcome boost to scheme returns.

The key to such ‘bond proxy’ investing is to execute within clearly defined risk parameters, ensuring that income streams are long in duration, secure in nature and progressive via inflation linked indexation. Core long-income investing into UK real estate can achieve all of these things if deployed within a strategy that targets secure income and strong terminal residual land values. Furthermore, with returns generated via a series of direct asset ownerships, the ability to acquire and manage within a sustainable framework can ensure responsible ESG investing. This paper explores the case for investing into UK core long-income real estate as part of a balanced investment strategy for mature DB pension schemes.