To look ahead at institutional appetite for private real estate in 2023, we must first look back at 2022 and acknowledge just how much the ball game has changed. It was a watershed year for the global economy. In the midst of a post-pandemic recovery, economies suddenly found themselves facing war in Europe and an ensuing crisis in both energy supply and consumer confidence. At the close of 2022, interest rates in the US and UK were at 15-year highs, following successive hikes – the scale of which had not been seen in decades – to attempt to bring inflation under control.
With the new cost of debt squeezing loan availability and upending balance sheets, investors began to question what real estate was really worth in this new environment. While public real estate indices soon felt the full force of this new rate environment, the private markets were, as ever, behind the curve, bringing dealflow to a near-standstill in the face of a wide bid-ask spread.
Against this backdrop, institutional investors were asked about their objectives for 2023, and how – or indeed whether – they plan to invest in different real estate sectors.
PERE’s Investor Perspectives 2023 Study provides a granular view of the market, both current and future, by gathering insight on investors’ asset allocation, propensity to invest and performance predictions. It is a global study, reflected in the question set and the respondents, which allows for cross-regional comparisons across asset classes.
The question set is reviewed annually in order to reflect market developments and shifts in sentiment. For this 2023 study, PERE’s Research & Analytics team surveyed 107 institutional investors in private markets, of which 52 allocate to private real estate. Fieldwork was carried out from September to October 2022, and participation in the study is always anonymous.
A correction is coming
Among surveyed investors, 21 percent said they were currently overallocated to private real estate. This is the highest figure since PERE’s 2018 study, and reflects the impact of the denominator effect in institutional portfolios amid a shake-up in asset values. It is therefore not a surprise to see that more than a third of respondents are looking to invest less capital in real estate over 2023, which is by far the largest proportion recorded in recent years.
Even so, more than half, 52 percent, of respondents are content to remain in an overallocated position, and a further 19 percent said they would wait for the market to correct. Adjusting allocation targets was selected by 17 percent, while only 12 percent intend to reduce their exposure through the secondaries market. This coincides with a year-on-year increase in the proportion of investors expecting to commit capital to real estate secondaries funds over the next 12 months, as well as those looking to offload fund stakes by that route.
Downward pressure on returns is to be expected given the widespread depreciation in asset values that is beginning to pick up speed. Indeed, almost one-third of investors said they expected real estate to underperform benchmarks in 2023. But where there is dislocation, there is also opportunity. In our survey this manifests in around a quarter of investors indicating a plan to increase capital commitments to each of real estate debt, opportunistic and value-add strategies. Conversely, the biggest pull-back is expected at the lower end of the risk spectrum in core and core-plus strategies.
Investments on the menu
When looking more closely at individual subsectors, our 2023 study reveals notable shifts in investor appetite compared with the previous year’s results.
When investors were asked which office investments they currently favor, one-quarter opted for large offices in city centers. This may have been the largest proportion, but it represents a drop of seven percentage points from the previous year’s study. However, it still exceeded the proportion of respondents that favor offices with a significant flexible-working component – although this itself has increased from 8 percent in our 2022 study to 20 percent in 2023.
In the residential segment, pressure on homeowners in a rapidly rising rate environment, high construction costs and the increased cost of development financing have combined to significantly dampen appetite for build-to-sell investments. While multifamily/PRS remains the favored residential subsector among investors, the proportion citing build-to-sell developments as a preference dropped from 23 percent to just 5 percent year-on-year.
In the retail sector, post-pandemic trends continue to tighten their grip on demand factors. City malls have seen a notable fall from grace in the eyes of investors: only 18 percent cited them as a preference in our 2023 study, down from 33 percent one year prior. Instead, retail parks have moved into the top spot.
Among alternative property investors, the largest proportion, 46 percent, still prefer data centers or other types of digital real estate, but this figure has dwindled from 62 percent the previous year. Instead, the proportions favoring healthcare property, self-storage and student accommodation have all increased year-on-year.
As banks and other traditional lenders crack down on loan requirements amid sky-high interest rates, investors are piling into debt funds in search of high returns. Senior debt is once again the most preferred real estate credit investment, but whole-loan debt has notably fallen from 24 percent of respondents to 14 percent in our 2023 study. In logistics, last-mile logistics assets are still out in front, extending their lead to 60 percent from half of respondents in 2022.