Average Size of Pension Funds

The dramatic fall in the proportion of real estate in pension fund portfolios since 1984 can also be partly explained by the changing nature of pension fund business. Of the large funds, traditionally big investors in real estate, several have had to deal with earlier than anticipated payments as employees accept early retirement, a direct

consequence of the recession. Also, many funds have progressively matured i.e. they show a greater intertemporal balance between cash inflows and outflows. Figure 2.4 below shows the ratio of annual pension fund expenses to income in the UK, often called the maturity ratio.

This is a consequence of the changing age structure of the UK population. For mature funds short-term liquidity, rather than matching long-term liabilities, has become an increasingly important consideration. This has led to the reappraisal of the role of real estate within many pension fund portfolios, compounded by the perceived  change in its performance characteristics. For example, due to changing financial markets, the role of real estates as a hedge against inflation has been undermined. The debt used to finance real estate in the 1960s and 1970s was typically long-term and fixed rate. During the inflationary late 1970's this benefited borrowers. Property owners not only paid a reduced, often negative, real interest rate, but also benefited from interest payments being tax-deductible. However, lending policies have changed. Commercial mortgages are being written over shorter time periods, in many cases at interest rates variable during the term. As Dohrmann [1995] has argued, this weakens real estate as a hedge against inflation. This is further discussed in section 2.4.6

Real estates role in the UK has been further affected by the relaxation of planning restrictions under the Conservative government,9 and technological advancements that affect the use value of commercial real estate.10 Both factors increase the uncertainty associated with real estate investment. 

This period has also seen smaller funds gain a larger share of the pensions market. These funds are less likely to invest directly in real estate because of the difficulties of creating a sufficiently diversified real estate portfolio; see section 2.4.3. According to a report published by DTZ Debenham Thorpe [1992], in the UK, pension funds of over £1bn in assets hold approximately 13.5% of their portfolio in real estate. For

those with assets under £0.25bn, the figure drops to 5.5%. Table 2.2 below demonstrates how the proportion of real estate held within a UK pension fund varies dependent upon its size. Similar evidence is found in the US; see tables 2.3 and 2.4 below. 

Thus three main factors may be highlighted as influencing life and pension fund investment in real estate. The short-term objectives of fund managers and availability of alternative investment opportunities, combined with the size and maturity of a fund. However due to the nature of life and pension fund liabilities, their objective must necessarily be long-term. While short-term performance may be of concern to fund managers, it should not colour the brush of fund trustees, and hence adversely affect the decision to invest in real estate. Secondly, while overseas investment may offer an alternative route through which to diversify UK equities, it does so by exposing a fund to an increased level of risk. As much research has shown, overseas investment reduces real estates role, but never replaces it.11 Lastly, while the fall in average fund size may preclude real estate from a number of

institutional portfolios, it does not explain the current weight of real estate in large life and pension funds. This therefore leads us to consider the main characteristics of real estate, together with additional factors that may affect the investment decision.


9For example, the changes in the Use Classes Order and Planning Policy Guidance; notes 12,16 and 18. The recent amendment to the Land & Property Act 1954, affecting security on assignment, will further reduce the value of real estate investment. This topic is further discussed in section 2.4.11.

10For example `hot-desking', a small, but increasing number of people working from home, and the Internet.

11See for example, Webb & Rubens [1987], Ennis & Burik [1991], Rydin, Rodney & Orr [1991] and Grauer & Hakansson [1995].