Housing Finance: Investment Opportunities For Pension Funds

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Public Disclosure AuthorizedPublic Disclosure AuthorizedPublic Disclosure AuthorizedPublic Disclosure AuthorizedFINANCE, COMPETITIVENESS & INNOVATION INSIGHT LONG-TERM FINANCEHousing Finance:Investment Opportunities For Pension Funds

2018 The World Bank Group1818 H Street NWWashington, DC 20433Telephone: 202-473-1000Internet: www.worldbank.orgAll rights reserved.This volume is a product of the staff and external authors of the World Bank Group. The World BankGroup refers to the member institutions of the World Bank Group: The World Bank (InternationalBank for Reconstruction and Development); International Finance Corporation (IFC); andMultilateral Investment Guarantee Agency (MIGA), which are separate and distinct legal entitieseach organized under its respective Articles of Agreement. We encourage use for educational andnon-commercial purposes.The findings, interpretations, and conclusions expressed in this volume do not necessarily reflectthe views of the Directors or Executive Directors of the respective institutions of the World BankGroup or the governments they represent. The World Bank Group does not guarantee the accuracyof the data included in this work.Rights and PermissionsThe material in this publication is copyrighted. Copying and/or transmitting portions or all ofthis work without permission may be a violation of applicable law. The World Bank encouragesdissemination of its work and will normally grant permission to reproduce portions of the workpromptly.All queries on rights and licenses, including subsidiary rights, should be addressed to the Officeof the Publisher, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA;fax: 202-522-2422; e-mail: pubrights@worldbank.org.

FINANCE, COMPETITIVENESS & INNOVATION INSIGHT LONG-TERM FINANCETABLE OF CONTENTSABBREVIATIONS AND ACRONYMSIIIACKNOWLEDGMENTSVEXECUTIVE SUMMARYVIIINTRODUCTIONPension Fund Investments in Housing FinancingMethodology and Approach113INVESTMENT OPPORTUNITIES FOR PENSION FUNDSSupply-side Investment OpportunitiesDemand-side Investment Opportunities557SUPPLY-SIDE INVESTMENT OPPORTUNITIES – DIRECT INVESTMENT IN HOUSING PROJECTSThe Pros and Cons of Direct InvestmentPreconditions for Successful Direct InvestmentEquity Investment in a Housing DeveloperPros and Cons of an Equity Investment in a Housing DeveloperPreconditions for a Successful Equity Investment in a Housing Developer9910111112SUPPLY-SIDE INVESTMENT OPPORTUNITIES – INVESTMENT IN HOUSING PORTFOLIOSCo-funding for Housing FundsPros and Cons of Co-funding for Housing FundsPreconditions for Successful Co-funding for Housing FundsInvestment in Real Estate Investment Trusts (REITs)Pros and Cons of REITsPreconditions for Successful REITs15151515151919SUPPLY-SIDE INVESTMENT OPPORTUNITIES – INVESTMENT IN SOCIAL HOUSING BONDS 23Pros and Cons of Investing in Social Housing Bonds23Preconditions for Investing in Social Housing Bonds24SUMMARY – SUPPLY-SIDE INVESTMENT OPPORTUNITIES27DEMAND-SIDE INVESTMENT OPPORTUNITIES - INVESTMENT IN PROVISION OFMORTGAGE LOANSPension Funds Investing in Intermediaries Offering Mortgage LoansPension Fund Taking an Equity Stake in a Mortgage OriginatorPension Fund Providing Wholesale Funding to an Intermediary29292929PUBLIC PENSION FUND GOVERNANCEHOUSINGANDFINANCEINVESTMENT:– INVESTMENTLESSONSOPPORTUNITIESFROM EUROPEFORANDPENSIONCENTRALFUNDSASIAI

DEMAND-SIDE INVESTMENT OPPORTUNITIES - INVESTMENT IN MORTGAGE SECURITIESPros and Cons of Mortgage SecuritiesPreconditions for Creating a Successful Mortgage Security MarketMortgage Securities – The Experience in Emerging MarketsCovered Bonds (on-balance sheet mortgage securities)Pros and Cons of Covered BondsMortgage Backed Securities (off-balance sheet mortgage securities)Pros and Cons of Mortgage Backed SecuritiesBonds issues by Mortgage Liquidity Facility (MLF)Pros and Cons of Mortgage Liquidity FinancePreconditions for a Mortgage Liquidity Facility3131333335363840404343SUMMARY – DEMAND-SIDE INVESTMENT OPPORTUNITIES45CONCLUSIONPension System ConsiderationsCountry-specific ConsiderationsAreas for Future InvestigationIn ST OF CASE STUDIESCase Study 1. Direct Investment – How Partnerships Unlock Emerging MarketsCase Study 2. Equity Investment in a Housing Developer – When Things Do Not GoAccording To PlanCase Study 3. Gauteng Partnership FundCase Study 4. Social Housing as an Investment Asset Class for Pension Funds1 –Opportunities in the UKCase Study 5. REITs in AfricaCase Study 6. Social Housing Bonds – The Australian ExperienceCase Study 7. New Dutch Approach to Mortgage OriginationCase Study 8. SA Home Loans – Securitization as a Funding ToolCase Study 9. Covered (Mortgage) Bonds – Chile’s Letras de CréditoCase Study 10. United States – Mortgage Backed Securities MarketCase Study 11. Nigerian Mortgage Refinance Company (NMRC) – On the Mark –Successfully ConnectingIITABLE OF CONTENTS1113161720243032373942

LIST OF FIGURESFigure 1. Total Assets in Funded and Private Pension Arrangements as a Percentage of GDP: 2016Figure 2. Pension Fund Allocation to ‘Land & Buildings’Figure 3. Investment Opportunities for Pension FundsFigure 4. REITs Across AfricaFigure 5. Mortgages Outstanding (By Country) as a Percentage of GDPFigure 6. Capital Market Facilitated Housing Finance in Emerging MarketsFigure 7. Mortgage Covered BondsFigure 8. The Mechanics of SecuritizationFigure 9. Mechanics of a Mortgage Liquidity FacilityFigure 10. Housing Investment Instrument by Level of Risk23621343536384147HOUSING FINANCE – INVESTMENT OPPORTUNITIES FOR PENSION FUNDSIII

FINANCE, COMPETITIVENESS & INNOVATION INSIGHT LONG-TERM FINANCEABBREVIATIONS AND ACRONYMSARMsAdjustable Rate Mortgage LoansCAHFCentre for Affordable Housing in AfricaCHPCommunity Housing ProjectCMOCollatoralized Mortgage ObligationDCDefined ContributionDBDefined BenefitGDPGross Domestic ProductGFPGauteng Partnership FundGSEGovernment Sponsored EntityHCAHousing Communities AgencyHFCHousing Finance CompanyHIFSAHousing Investment Fund South AfricaMBSMortgage Backed SecurityMoFIMinistry of Finance IncorporatedMLSMortgage Liquidity FacilityMMSMortgage Market SystemNMRCNigerian Mortgage Refinance CompanyOECDOrganization of Economic Cooperation and DevelopmentPMOPrimary Mortgage BanksPAYGPay As You GoREITReal Estate Investment TrustRPIRetail Price IndexSAHLSouth African Home LoansSARBSouth African Reserve BankSPVSpecial Purpose VehicleRSCRegistered Social LandlordSIBSocial Impact BondSIISocial Impact InvestingTHFCThe Housing Finance CorporationWEFWorld Economic ForumWHCWatumishi Housing CompanyZARSouth African RandHOUSING FINANCE – INVESTMENT OPPORTUNITIES FOR PENSION FUNDSV

FINANCE, COMPETITIVENESS & INNOVATION INSIGHT LONG-TERM FINANCEACKNOWLEDGMENTSThe authors of this paper are Linda Sing (Adjunct Faculty Member of the University of Pretoria’sGordon Institute of Business Science), Fiona Stewart (Lead Financial Sector Specialist ofthe World Bank Group) and Simon Walley (Lead Financial Sector Specialist of the WorldBank Group). Research and input for the report were provided by Guillermo Larrain (Professorin the Economics Department of the University of Chile) and Eun Jung Park (Operations Officer,World Bank Group). Comments were also gratefully received from the following World Bankcolleagues Loic Chiquier, Mark Davis, Ekaterina Gratcheva and Andrey Milyutin. Appreciation isalso extended to Aichin Lim Jones for design and layout support. This paper was presented at TheWorld Bank Group’s 8th Global Housing Finance Conference “Breaking the Mold”, held from 30May to 1 June 2018 in Washington D.C.HOUSING FINANCE – INVESTMENT OPPORTUNITIES FOR PENSION FUNDSVII

FINANCE, COMPETITIVENESS & INNOVATION INSIGHT LONG-TERM FINANCEEXECUTIVE SUMMARYThe global housing deficit in both developed and developing countries is increasing – drivenby demographic and other mega-trends including urbanization and income inequality.Global pension fund assets, on the other hand, are both growing and increasingly lookingfor long-term, productive investments.There are multiple avenues through which pensionfunds can invest in the housing sector. ‘Supplyside’ investment opportunities range from directinvestments in housing projects or investments inhousing developers, to investments in housing fundsor social housing bonds.‘Demand side’ investment opportunities includea range of investments in mortgage securities whether covered bonds, mortgage-backed securitiesor via bonds issued by mortgage-liquidity facilities.1However, the supply and demand sides of theequation do not fit together as neatly in practice as onpaper. One key point to note is that the regions wherethe funding for affordable housing is most pressingare generally the jurisdictions with the lowestpension fund coverage for its citizens. Therefore,with notable exceptions, where the financing isneeded the most, access to domestic pension fundassets are least available.Even amongst the largest, most sophisticatedand mature pension funds, investments in ‘landand buildings’ (under which housing is generallycategorized) remain relatively minimal, comparedto the asset categories where most of the assets aretypically invested, i.e. bills and bonds, shares andmutual funds. In addition, the prevailing legal orregulatory regime may also restrict pension fundsfrom investing, which impacts the type of housingfinance investment or investment instrument that isadopted by pension schemes. In addition to creatinginstruments with the appropriate risk-return profile,past experience showed that without the right kindsof incentives, mobilizing pension fund assets forhousing investments can be constrained.It appears as though some inroads are already being madein linking invested pension fund assets with investmentsin housing developments in specific developingeconomies. Nevertheless, it is also evident that thereremains significant potential for more investment bypension funds in housing-related instruments. Severalfactors are needed for the ‘stars to align’ including:a supportive legislative framework; trustees must betrained so that they are understand and are comfortablewith housing investments and the risks involved (whichvaries considerably by products), and can include themin their investment mandates; having pension funds ofsufficient size to make these investments and build thisknowledge is required - which generally means large,funded schemes, often from the public sector with someadditional development mandate; pension schemes witha younger membership and offering less investmentchoice to members are better placed to invest in moreilliquid asset, which housing investments often represent.Products which cater to a large numbers of informalsector workers are needed to make the pension andhousing savings link in developing countries – whichwill also need to attract foreign pension investment toprovide the scale of capital required.None of this will take off without stable macrofundamentals, well-developed capital markets,and indeed a well-developed housing sector (withestablished developers and construction companies,vibrant home ownership and/or rental markets, robustregistration along with political will and supportingpolicies to advocate for investment in housing).Data showing the extent to which and how pensionfunds are investing in housing is still limited anddeserves further research. Further policy andregulatory guidance on the different investmentvehicles is also required.HOUSING FINANCE – INVESTMENT OPPORTUNITIES FOR PENSION FUNDSIX

FINANCE, COMPETITIVENESS & INNOVATION INSIGHT LONG-TERM FINANCEINTRODUCTIONThe global housing deficit is expected to burgeon to one billion units by 2025 and is estimatedto cost an estimated US 650 million per year – or between US 9 trillion and US 11 trillionin total.2 Other sources put the overall cost at US 16 trillion, if the cost of land is factored in.3The provision of affordable housing is a long-standing policy challenge,4 but is being exacerbatedby well-known demographic trends, including urbanization5 and global inequality, which is pricingeven middle-class households out of ownership in many countries.6 A staggering 90 percent ofurban growth by 2030 will occur in Africa, Asia, Latin America and the Caribbean.7 Governmentscannot be expected to finance the entire housing deficit and policymakers are looking to the privatesector to elp support the developmental objectives in the housing sector.Pension Fund Investments inHousing FinancingPension funds – with over US 38 trillion assetsin OECD countries alone8 – are one of the largestsources of private sector investments, and potentiallysources of housing finance. In terms of the value ofassets held by private pension funds as a percentageof GDP, the weighted average for OECD countriesis in the region of 140 percent of GDP, whereas fordeveloping economies (in the OECD sample), theweighted average is 40 percent of GDP. Whilst thisdata only represents a ‘slice’ of the total market, it isa useful proxy for the global situation.The key point to note is that the regions/areas/economies where the funding for affordable housingis most pressing, are generally the jurisdictions withthe lowest pension fund coverage for its citizens.Therefore, where the financing is needed the most,access to domestic pension fund assets are leastavailable. There are obviously notable exceptions,for example, in South Africa where the value ofprivate pension assets as a percentage of GDP is inthe region of 100 percent. (See Figure 1)Given the low interest rate environment since theglobal financial crisis, these funds are increasinglylooking for long-term, stable returns, uncorrelatedwith global markets.9 Yet, it is notable in theOECD sample, that even amongst the largest, mostsophisticated and mature pension funds, investmentsin ‘land and buildings’ – which is how housinginvestments are generally classified10 – remainedrelatively minimal, compared to the asset categoriesremain where most of the assets are typicallyinvested, i.e. bills and bonds, shares and mutualfunds. Pension funds in many developing economiesinvest predominantly in government bonds, that arebasically deemed to be risk-free.11 However, it is alsointeresting that some developing countries featurehighly on this list of exposure to land and building– largely due to the lack of alternative capital marketopportunities. (See Figure 2).In addition, the prevailing legal or regulatoryregime in housing may also restrict pension fundsfrom investing. An inadequate legal and regulatoryframework governing alternative investments hasbeen cited as one of the major reasons for a lackof pension fund investment in the sector.12 For13or example, while many countries have legislatedto allow for pension funds to invest in real estateinvestment trusts (REITs), this is only a recenttrend.14 Other pension schemes, either on their own,or driven by national policy, have adopted a socialimpact agenda which is supportive of and facilitatesinvestments in housing.15 Such factors have animpact on the type of housing finance investment orinvestment instrument that is adopted by the pensionscheme.HOUSING FINANCE – INVESTMENT OPPORTUNITIES FOR PENSION FUNDS1

Figure 1. Total Assets in Funded and Private Pension Arrangements as aPercentage of GDP: 2016OECD CountriesDenmarkNetherlandsCanadaIcelandUnited StatesSwitzerlandWeighted AverageAustraliaUnited KingdowSwedenChileFinlandIsraelSimple AverageIrelandJapanKoreaNew ZealandMexicoEstoniaSpainLatviaSlovak RepublicPortugalNorwayFranceItalyPolandCzech LuxembourgGreece04080Selected Non-OECD Jurisdictions120160200240South AfricaNamibiaLiechtensteinSingaporeWeighted AverageMaltaHong Kong (China)El ple AverageCosta RicaKenyaBrazilDominican RepublicMaldivesBulgariaMalawiTanzaniaFYR of biaAlbaniaPakistan2006040801201602002402016Source: OECD, 2017.To be attractive to investors, housing investmentopportunities – including mortgage security yields –will have to reflect risks associated with alternativeinvestment options, including credit risk, liquidityrisk, market risk and prepayment risk. The challengeis how to create housing investment instrumentswith the right risk-return profile for these investors toallow pension funds to provide access to longer-termfinance through capital market instruments (such ascovered mortgage bonds, securitization etc.).162INTRODUCTIONIn addition to creating the appropriate risk-returnprofile, past experience showed that without the rightkinds of incentives, mobilizing pension fund assetscan be constrained. For example, Colombia had putin place tax exemption on yields for banks and otherpotential investors, thus pushing yields down, whileit affords no value to tax-exempt pension funds,thus limiting pension funds’ demand for mortgagebacked securities.17

Figure 2. Pension Fund Allocation to ‘Land & Buildings’TanzaniaZambiaSurinamKenyaPapua New GuineaFinlandSwitzerlandMalawiSlovak eaIsraelDenmark0510Methodology and ApproachThis paper investigates the possible long-terminvestment opportunities in the housing sector fromthe perspective of the supply- and demand- sides ofthe housing value chain. The report will focus on thesupply- and demand- side investment opportunitiesavailable to pension funds. The mechanics of theinvestment opportunities will be discussed, togetherwith the pros and cons, and necessary preconditionsthat need to prevail in order to facilitate successfulinvestment. To further elaborate on the investmentopportunities and to take cognizance of lessons learnt,potential investment approaches are illustrated byavailable case studies. Finally, the paper will proffer15202530suggestions for creating a facilitating environmentfor long-term investment in the housing sector bypension funds and put forward recommended areasfor future research.The paper is based predominantly on desktopresearch and input from a select number ofhousing and pension fund specialists. This reportis mainly a ‘qualitative’ descriptive survey of thetypes of investment which pension funds’ makeinto the housing sector. It is meant as an overview,introductory piece, and does not provide quantitativedata on to what extent pension funds do, could orshould have exposure to housing.HOUSING FINANCE – INVESTMENT OPPORTUNITIES FOR PENSION FUNDS3

FINANCE, COMPETITIVENESS & INNOVATION INSIGHT LONG-TERM FINANCEINVESTMENT OPPORTUNITIESFOR PENSION FUNDSPension funds have multiple avenues to invest in the housing sector. To ensure that thereis a seamless matching of accumulated savings (through pension funds) with long-terminvestment opportunities, several conditions are necessary to facilitate transactions: Potential long-term investors should not beconstrained in their ability to provide financingby barriers, such as incentives and restrictions onportfolio allocations. Long-term financing in many countries are oftenconstrained by the narrowness of the range ofavailable instruments. Policymakers intent onunlocking new sources of long-term financeshould foster the growth of new markets andinstruments that can fill the gap between thecurrent sources and projected future demand forlong-term investment. Often bond, equity andsecuritization markets in developing economiesare not sufficiently mature and liquid. Many rapidly industrializing and urbanizingemerging markets will need foreign investors tohelp fund capital-intensive investments, if theydo not have sufficient domestic savings to fundgrowth. An enabling environment that allows formore stable flows of long-term capital (such asforeign direct investment) to countries wi

There are multiple avenues through which pension funds can invest in the housing sector. ‘Supply side’ investment opportunities range from direct investments in housing projects or investments in housing developers, to investments in housing funds or social housing bonds. ‘Demand side’ investment opportunities include

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