Investing in residential real estate can offer benefits to pension plan sponsors, but it’s not an asset class that’s easy to access. However, a new strategy exists that harnesses the power of quantitative investing to make this option feasible for pension plans.
Residential real estate should be top of mind for any institutional investor, said Rayan Rafay, chief investment officer at Unison Investment Management, during a session at the Canadian Investment Review’s 2019 Defined Benefit Investment Forum on Dec. 6 in Toronto.
Firstly, it can help if inflation is a concern, he said, noting every piece of inflation over the last 10 years has been flat to negative except for housing, health care and education. “And services are exceedingly difficult to hedge from an inflation perspective. Goods are relatively straightforward. But housing provides an inflation hedge in a direct fundamental way that really no other asset can.”
As well, the correlations are incredibly low with other asset classes, he added. And housing is the single largest component of gross domestic product.
Despite these benefits, it isn’t easy to access residential real estate. It requires scale, normally requires boots on the ground in multiple cities and only makes sense to operate a buy-and-rent model in geographies where the rent is higher than the cost of carry, Rafay noted.
“That immediately eliminates you from all the core cities in the world. You can’t operate a single-family strategy in New York or Toronto or San Francisco or Los Angeles or Boston or Washington, D.C.”
It also involves social risks, he added. “If you’re a pension plan or an institutional investor, really the last thing you want to be in is a business where you are in a headline for dealing with evicting tenants. . . . Imagine if you were a pension plan in Toronto and you ended up evicting one of your pension plan members.”
But one way pension plans can gain exposure to this asset class is through home co-investments.
For instance, when a homeowner makes a 20 per cent down payment on a home, they can contribute five per cent and the investment manager can contribute the other 15 per cent. Or, if a homeowner wants some additional cash, they can release some equity in their home to the investment manager instead of going the route of a reverse mortgage or home equity line of credit. When the time comes to sell the house, the investment manager shares in the profit or loss. Alternatively, the homeowner can buy out the investment manager.
“From a homeowner’s perspective, what we’re really trying to do is detach the concept of house and home,” Rafay said. “Home is that place that gives you permanence, it’s where your family resides, it’s the sticky memory. And the house is the asset. And those should really be two different things, because you should really own as much or as little of a house as is prudent for you based on your financial objectives.”
For the investor manager, the benefits of this strategy include gaining access to the asset class without worry about property management, which rests with the homeowner.
“Now from the investors’ perspective, the way this looks is you put $150,000 into a home and in exchange for that you get the economic exposure of a $500,000 house, without any cost of debt. And so it’s structural leverage that you effectively are getting without any cost for it.”
However, this is only possible at scale due to technology, since choosing the houses to invest in has machine learning at its core and uses a quantitative approach. “If someone goes onto our website, they put in an address, within three seconds they get a response back of whether or not we would invest in that property,” Rafay said. “And that’s really a pre-approval that allows us to do this at scale.”
For appraisals and physical inspections, Unison runs a machine-learning model that looks at images and text, only escalating the properties to a human if this process suggests an issue, he said.
“There’s a number of areas where we’ve had to introduce technology because you simply can’t invest in thousands of homes across thousands of cities without being able to leverage technology.”