von Jarkko Lehtonen, PM UB Nordic Property Fund.
Real estate is increasingly becoming a significant element of asset allocation among institutional investors with a long-term focus. Even before the Covid-19 crisis, institutional investors had seen real estate as an integral part of their portfolios, and at United Bankers, we believe that this trend will continue.
Relying on an open-ended structure, the UB Nordic Property Fund has built a well-diversified portfolio of “Core Plus” commercial properties across the Nordic countries to provide investors the opportunity to tap on attractive real estate returns. A Core Plus strategy involves taking more risk than a “Core” strategy and implicitly going up the risk curve by investing in what are known as secondary locations. The additional risk associated with these secondary locations is balanced by long-term leases with high quality tenants in our portfolio.
Diversification Source One: Geographies
UB Nordic Property Fund owns a well-diversified portfolio of 46 different properties that generate stable cash flows for the fund and its investors. In our Core Plus strategy, we want to give our investors the benefit of the stable rental income the properties in our portfolio generate. These stable return sources are an important part of the value proposition of this fund, as is its diversification. When UB Nordic Property Fund was launched in 2016, the fund was offered primarily to Finnish asset owners, most of whom already had significant direct exposure to Finnish real estate. The aim was to provide these institutions exposure and diversification to the broader Nordic real estate markets.
UB Nordic Property Fund’s portfolio, which had a market value of €354 million as of the end of 2020, had at that time an exposure of 47 percent to Norwegian properties, 23% to Danish, 16% to Swedish and 14% to properties in Finland. The Norwegian property market has been of interest to the fund for many reasons, one of which revolves around the difference between the economic landscapes of these four countries.
While Sweden, Norway, Denmark and Finland appear to be fairly similar, the characteristics of each economy are distinctive in their own way. Our current level of exposure to the Norwegian market, for example, reflects our assessment of the opportunity set in Norway and therefore provides the best diversification for all of our investors, regardless of where their domestic property market is.
Diversification Source Two: Property Types
We hold several different types of commercial properties. That is the most important principle behind this well-diversified portfolio. The fund has approximately 51 percent of its portfolio invested in logistics properties, 37 percent in office properties and 9 percent in retail properties; the remainder is invested in what we define as special opportunities. During these past two years, we have been most active in the industrial segment, consisting of logistics and production facilities, which has turned out to very successful, especially in light of the ongoing Covid-19 pandemic. Investors are focusing on logistics, and the need for modern facilities is pressing in the Nordic region, as it is in most developed countries around the world.
The retail segment of the property market, on the other hand, has been under stress for much of the past decade. E-commerce has been steadily growing over the past several years and the Covid-19 pandemic has just accelerated the shift. With an increased share of work being done remotely, property investors are also worried about the impact of the pandemic on office properties. We have seen the office segment undergoing structural change for some time and the inevitable work-from-home trend has only added to the headwinds in the short-term.
The future of offices is still under debate, and we question the simplistic notion that Covid-19 will “kill the office”. This pandemic accelerated the change that would inevitably take place. We are observing a change in how customers use office premises, but in the longer term, we do not expect to see a future where companies do not need offices anymore. These trends had been there before, they have just accelerated during the Covid-19 pandemic.
On the Open-Ended Structure, Liquidity Mismatches and Avoiding Speculation
Institutional investors tend to have an extended investment horizon and real estate properties are well suited for such long-term-oriented investors. Occasionally, however, cash is scarce and there may be a demand for liquidity. The open-ended structure of the UB Nordic Property Fund enables investors to exit from their investments on a quarterly basis. These open-ended Alternative Investment Funds (AIFs) domiciled in Finland are attractive because they offer improved liquidity to investors.
Better liquidity is a good thing for investors but does represent a certain challenge for the fund managers. Because real estate is not a very liquid asset class as such, there is some degree of liquidity mismatch here. In reality, this mismatch did neither pose a problem for UB Nordic Property Fund during the cash-strapped environment in the first quarter of 2020, nor during the somewhat uncertain period that followed. In the Covid-19 crisis, our worst quarter in terms of redemptions was the end-of-June quarter 2020, but we only had a few million euros in redemptions. We are confident that we have managed to communicate properly to our investors that our vehicle is essentially a long-term investment and there is no point in worrying about short-term fluctuations.
The open-ended structure also enables United Bankers to build a growing, more diversified portfolio of properties with an attractive risk-return profile. In a closed-end structure, you are quite exposed as a fund manager to timing [the market]: you have to start buying assets immediately after raising capital and then ultimately required to sell all the properties at end of the fund’s tenure. With an open-ended fund, both new and existing investors have the opportunity to get exposure to an increasingly more diverse property portfolio. A bigger fund size also definitely helps the fund manager, making it a more attractive partner in the eyes of property sellers, brokers, service providers and other stakeholders.
In our experience, a bigger fund size arguably also helps in fundraising, as attracting investors with this kind of dynamic diversification is actually easier. It is simply less of a leap into the unknown for the investor to make that investment decision. We would not mind the fund growing to become twice the size it is today, as it arguably gives added value to both existing and new investors to have a larger, hence more diversified portfolio.
In terms of what investors should expect from an investment in the UB Nordic Property Fund, we point out that every year we aim at paying out an annual dividend of up to five percent. The team running the fund has managed to pay out a that successfully in the previous two years. That is something we want to keep doing. Our team has succeeded in building a very attractive portfolio, which has a weighted average unexpired lease term of 8.7 years. Our initial yield is 6.3 percent, which is remarkably high. As we apply leverage, with our loan-to-property portfolio now leveraged up to 54 percent, we can achieve an ROE of 9 percent.
In this Core Plus strategy, we want to give our investors the benefit of stable income, without hard assumptions on the future value of the properties. We want to stress that investors’ returns from this fund ultimately come from the real rental income rather than value appreciation. Speculation is not how we manage funds at United Bankers. We do not buy properties for an expected value uplift; we buy properties for their real income potential.
Jarkko Lehtonen, Portfolio Manager, (MSc in Eng., Helsinki University of Technology), has been working with real estate for more than sixteen years. He worked for seven years in the Kesko Group with real estate leasing and sales. In 2011 Jarkko founded Capitol Asset Management and took over the management of a portfolio of 77 grocery properties on behalf of Sveafastigheter Ab (a Swedish property investor). In June 2014, Jarkko was involved in selling the portfolio to another Swedish property investor Redito. LinkedIn
United Bankers Plc (UB) is a Helsinki-based Financial Services group. Founded in 1986, UB started its business in securities brokerage. Today, the company's business areas include Asset and Wealth Management and Capital Markets services.
UB is a Nordic pioneer and a global specialist within Real Asset investments. In Wealth Management, UB offers discretionary Asset Management to private and institutional asset owners in Finland and Sweden
UB Fund Management Ltd, established in 2007, is a subsidiary within the group, dedicated to the administration of investment funds. These include European Union UCITS regulated vehicles as well as AIFMD regulated funds.
For more information, please refer to UB’s website at www.unitedbankers.com