As published in the Financial Express on 25-Feb-2020 Newspaper Link
High net worth individuals (HNIs) have been engaging with financial advisors to plan for their retirement and to financially secure the future of their children. The former has historically been done through investing in a basket of securities that provide a monthly cash flow and the latter through the use of private trusts that release funds once the child reaches a particular age.
Both of these strategies require the release of an annuity income that is hedged against inflation. This means that the returns would have to be able to purchase the same basket of goods and services year after year.
Traditionally, HNIs have relied on a mix of debt and equity investments in order to plan their retirement and provide funds for their children. However, recently, the sector has seen a move to more alternative asset classes that provide instruments that more effectively match cash flows with liquidity and inflation.
One such asset class that has seen a significant increase in allocation is commercial real estate. Commercial real estate provides 8-12% annual returns through rental yield and an opportunity to participate in the appreciation of the underlying property, giving it characteristics of both debt and equity. By virtue of being a real asset, the principal amount is also considerably safer. The real icing-on-the-cake is the annual inflation-linked rent escalations. Most commercial leases escalate by 5% every year or 15% every 3 years, providing a strong cushion against inflation.
If invested in an institutional grade property with a blue-chip tenant, the credit risk of rents not being paid or the tenant vacating can be significantly reduced. A seasoned real estate investor will increase stickiness by requiring the tenant to do the fit-outs or tenant improvements (TIs) and by signing a “lock-in”, a term used to bind tenants to a building for a longer term.
The recurring monthly cash flow, through rents which are paid monthly, is an important source of steady annuity income that can be reinvested in other assets like a Systematic Investment Plan or withdrawn to meet daily expenses. With a sufficiently large investment corpus diversified across tenants, geographies and asset classes, these monthly cash-on-cash returns can ultimately enable HNIs to become financially independent.
| Investor | Real Estate ($ bn) |
| 1. Allianz Real Estate | $72.4 |
| 2. China Investment Corporation (CIC) | 52.9 |
| 3. Abu Dhabi Investment Authority (ADIA) | 51.2 |
| 4. APG (Dutch Pension Fund) | 48.4 |
| 5. TIAA (Teachers Insurance and Annuity Association of America) | 47.2 |
| 6. AXA | 36.3 |
| 7. Temasek (Singapore) | 35.3 |
| 8. QIA (Qatar Investment Authority) | 35.0 |
| 9. CPPIB (Canadian Pension Plan Investment Board) | 33.9 |
| 10. CalPERS (California Public Employees’ Retirement System) | 33.4 |
Source: Top 100 real estate investors (June 2019, IPE Real Assets)
As a result, the asset class has allured investments from some of the largest sovereign wealth funds, pension funds and investment managers. As per IPE, some of the world’s largest institutional investors invested $33-72 billion into the asset class in 2019.
One possible drawback of commercial property investing is liquidity. By virtue of being a real asset, a commercial property is not easily liquidated vs equity or debt instruments. This may be resolved by investing a part of the portfolio in liquid instruments like mutual funds and fixed deposits.
Kunal Moktan
The author is the co-founder and chief investment officer at PropShare Capital, India’s first and largest commercial property investment platform.