Tony Brown
M&G

M&G’s chief investment officer Tony Brown talks market trends, strong growth and the value of investing sustainably. Theo Andrew reports

M&G Real Estate transacted over £4.1 billion in 2016. Do you expect this to be as strong in 2017?

We are still seeing strong demand from our institutional investors, but competition means finding assets in the market can be hard. In continental Europe, we will be transacting as much if not more than last year. As a business, 2016 was the first year that M&G transacted more in continental Europe than we did in the UK, which is likely to be repeated again, reflecting the level of client demand in Europe.

In Asia, we are growing our core fund. We have the largest pan-Asian institutional core fund in the market, which continues to grow, so we will be transacting the same if not more than last year.

In the UK, we have been quite successful in raising new capital. In February, we won a separate account from a European client for $500 million to invest in the UK, which we are starting to transact now. We also have new capital to invest in the UK from our parent company Prudential.
Are there any asset areas that are of particular interest going forward?

We have two areas in particular that remain strong in the UK. Firstly, residential investment. We are one of the leading private rented sector (PRS) investors in the UK and we have raised about £700 million in total over the last four years, since the launch of our PRS fund.

Local authority pension funds have been particularly interested, as they are attracted to the investment story as well as the social story, that is, providing affordable housing for working people. PRS is evolving and becoming more mainstream compared to three or four years ago, and I think it will continue to grow. There are a number of participants who are trying to bring it into the institutional market.

Similarly, around 30 years ago in the US, there wasn’t much institutional investment in multi-family, or PRS, however, now it has developed to about a quarter of the market for commercial real estate. In the UK, however, it is a very small percentage of commercial real estate investment into residential, so there is a potential for the market to grow quite significantly.

Secondly, another important area for us is long-income real estate investing. It’s property similar to a fixed-income investment, meaning you have a good quality tenant that pays rent over long periods, such as more than 30 years, linked to inflation. These are becoming increasingly popular for investors who can’t find much yield from fixed income, but who like long-term assets because they can get an attractive yield pick-up of say 200 to 300 basis points higher than through investing in illiquid assets, generating a higher cash flow.

We often refer to them as ‘super-core’ investments and they are incredibly popular because of the income that they can deliver. We are doing this in the UK but also in continental Europe, where we’re the first fund manager to develop this strategy. We launched a fund 18 months ago that has proved to be popular with European investors.

It’s a well established model in the UK, and we’ve been running these strategies for more than 10 years. In continental Europe, long leases aren’t as prevalent and regulations in some countries restrict the length of leases, but we found that there are enough jurisdictions where occupiers are prepared to enter into long leases to finance their accommodation. We raised a significant amount of capital and we have started investing it in a number of deals over the last year.

Continental Europe is an opportunity because there is a significant amount of owner occupation of property. Typically, corporates own property on their balance sheets, but we think that is going to change. If you can sell the property and pay a rent linked to inflation then you can release capital for your mainstream activities without having it tied up in a property.

PRS is something of a buzzword at the moment, what exactly is it? And what is attracting you to the sector?

Demand is growing for the rental model and apartments are now being designed specifically for this market. We are interested in funding this type of investment where it delivers a long-term cash flow.

In reality, it is still quite a new area for UK developers.

The difference between the build-to-rent model as opposed to the build-to-sale model, for example, is in a two-bedroom flat where both bedrooms need to be the same size with equal access to bathrooms, because people are more likely to be sharing with friends. Under the rental model, you need to make sure it’s pretty hard-wearing to avoid capital expenditure that drags on your returns.

Communal space is important to garner the feeling of community. This may take the form of an amenity room or a rooftop allotment, which we have introduced at our North Acton development. It’s definitely an emerging market that will become a staple in the institutional market over the next few years.

In addition, we are competing with house builders whose traditional model is to build and sell. Typically, the value you can derive from the build-to-rent model is less than the build-to-sell model.

However, if you are a house builder and you agree a rental funding before you start building, particularly in a multi-phase development, it allows blocks to be built more quickly, and because people can occupy the apartments faster, their value is increased in the later phases. The profit might not be so high for the house builder, but it reduces the risk for them.

M&G prides itself on its responsible investment strategy. What does this entail?

We build sustainability into our investment process and we have our own sustainability team. Traditionally we have concentrated on environmental issues such as energy use and carbon, for which we have quite strict targets, however, we have just started to look at our social impact as well.

We believe that we’re the first real estate manager to conduct a report of our social and economic impact across our whole global portfolio. We have examined the levels of employment through our supply chain and by our occupiers, that is, our shopping centres or office buildings. We have also looked at how many people come through our retail outlets every year and how much they spend.

Finally, we have been measuring community engagement and the overall social impact that our actions have in the economy, as it’s indicative of a wider change within the business community.

What markets are the most attractive to M&G at the moment?

In certain parts of Europe we are seeing not only strong investment demand but also strong occupational demand. For the first time since before the financial crisis we are starting to see some genuine rental growth emerge in some parts of continental Europe. For example, we have been investing in offices in Stockholm and Madrid, where rental growth has increased in double figures due to the lack of new buildings and because the economies are recovering.

Investment demand for continental Europe is a bit later in the cycle than in the UK and the US, but now we are seeing pockets of rental growth, which is encouraging in terms of forecast returns for the European markets.

As is often the case when rents begin to rise, when there is a lack of choice for occupiers and genuine competition for space, rents jump up pretty dramatically, higher than inflation. That’s what we are seeing in selective markets in continental Europe at the moment.

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