UK insurers' have "picked up the slack" from pension funds' reduced demand for commercial ground rent assets in the last 18 months, as DB pension schemes' funding has improved due to the higher rates environment, according to specialist investment manager AlphaReal.
The comments were made after proposed government regulatory changes that would potentially restrict residential freeholders' ability to set higher ground rents for leaseholders.
AlphaReal added that it expected insurers to continue to dominate the £5bn-£6bn institutional market for commercial ground rents, estimating insurers represent 85% of that total. It added the total market size was £30bn-£35bn, which, in addition to institutional investors, included non-institutional bodies such as the Crown, City of London, Canary Wharf Group and Local Authorities, it explained.
It added that a number of insurers had been ready to take to the market two years ago, but the sector had accelerated its participation in the last 12 months as pensions schemes found themselves with high allocations to illiquid assets.
Boris Mikhailov, head of client solutions at AlphaReal, commented: "These assets not only allow [insurers] to improve their current portfolios, but also helps them competitively price deals in the booming pensions risk transfer market – where well-funded schemes are looking to transfer liabilities to insurers."
The asset manager said insurers participating in the commercial ground rents market were "almost entirely" bulk annuity insurers, which were likely looking to achieve returns above similarly rated corporate bonds, and drawn by matching adjustment eligibility. It added that ESG the benefits of commercial ground rents were increasingly another attraction for insurers.
The manager added it expected institutional investors to participate in £1.5bn-£2.5bn of new deals coming to the market annually, with potential for this to grow as the market becomes more established.
Commercial ground rents were attractive to insurers due to the long-dated, inflation-linked, investment-grade quality nature of their cashflows that generate attractive returns and are treated favourably under Solvency regulations, AlphaReal explained. "There are simply no other asset classes that can provide inflation-linked cashflows beyond 40 years and a yield over and above comparable index-linked gilts," Mikhailov said.
Mikhailov added there was "no suggestion that any reform is needed" in commercial ground rents, however, saying that insurers have been looking to transact in the commercial ground rent market for several years.
At time of writing, the Department for Levelling Up, Housing and Communities had not confirmed to Insurance Asset Risk whether the proposed reforms applied only to residential ground rents.
However, when approached for comment on the government's proposed ground rent changes, a number of the UK's largest insurers and affiliates, including Legal & General Investment Management, Allianz Global Investors, Aviva Investors, Direct Line Group, and Axa IM, declined to comment.
The government's consultation on proposed changes to ground rents was opened on 9 November, and included five possible changes to existing leasehold agreements, including: capping ground rent at a peppercorn; capping ground rent at an absolute maximum value; capping ground rents at a percentage of the property value; capping ground rent at the original amount it was when the lease was granted; and freezing ground rent at current levels.
The ABI also said it was still "early days" in digesting the government consultation, and that it would continue to speak to its members about the proposed changes.
