29 October, 2019

There has been a substantial change in the UK pensions landscape in the last decade. Membership of UK private sector occupational Defined Benefit (DB) schemes has fallen from 2.8m people in 2008 to 1.1m people now, as these schemes close and mature. Meanwhile, UK Defined Contribution (DC) pension scheme membership has soared, from 1m people in 2013 to over 10m people in 2018. This increase is driven primarily by the Government’s decision to force companies to ‘auto-enrol’ workers in a pension scheme if they do not otherwise have one.

Figure 1 Membership (millions) in private sector pension schemes

Pensions research blog_graph 1

Source: ONS

So, the amount of money flowing into UK pension funds (mostly DC schemes) is increasing rapidly. While the assets held by DB schemes still outstrip those of DC schemes (one IPF estimate for 2015 suggests £1.3trn and £300bn respectively), growth in DC schemes assets is outstripping growth in DB scheme assets.

As DB schemes mature, they become more risk-averse, reflecting the need to reliably pay out pensions month after month, rather than investing contributions for the long term and not worrying too much about short term cashflow. This risk aversion tends to involve selling (riskier) equities and buying (safer) bonds.

The received wisdom is that DB pension schemes are also incentivised to sell real estate, given its illiquid nature and the income risk associated with void periods. But in fact ONS data shows that, over the last 10 years, pension fund real estate allocations have stayed broadly stable at around 5%.

However, within that real estate allocation, pension funds appear to be selling real estate that behaves like equities and buying real estate that behaves like bonds. It is difficult to pin down, but there is strong circumstantial evidence that pension fund decisions are one driver of strong recent inflows of cash into so-called ‘long income’ real estate funds, which hold assets such as 25-year leases. CBRE now values £15bn of long income assets; our quarterly Long Income Index tracks their performance. Long income is attractive because it provides long-term, steady, contracted income, often directly indexed to inflation. Thus it is ideal to match to pension liabilities. By contrast, since 2015, traditional real estate funds have seen net outflows.

Figure 2 Cumulative net new investment in property funds (£m, LHS) and Long Income’s share of that investment (%, RHS), 2005-2019, quarterly

Pensions research blog_graph2a

Source: CBRE Research, MSCI

This move away from traditional funds to cashflow-driven, liability-matching long income funds is not, however, driven entirely by pensions reform. There are other reasons why pension funds are selling real estate right now – not least the uncertainty created by Brexit.

In any case, the behaviour of DB schemes is arguably the less important bit of the picture. DC schemes probably allocate around 2% of their funds to real estate compared with 5% for DB schemes.

There are good reasons why DC schemes might always allocate less. But the sheer growth in DC scheme assets and the relative youth of their membership suggest that DC will be a fresh and growing source of real estate investment from now on.

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