US public pensions pulled back significantly on their real estate equity allocations during the second quarter, in what could be a sign of a larger slowdown, according to a new report from FPL Consulting.
Commitments to real estate managers have been declining since the fourth quarter of 2015, when total earmarks were reduced from $13.2 billion to $8.2 billion, before bouncing back to $11.8 billion in the first quarter of 2016, according to the Chicago-based advisory firm, which has tracked commitments since 2011. Real estate commitments then fell again to $9.1 billion from April to June, the firm said.
“We’ll know whether this is an enduring trend once third-quarter data comes out,” Tim Kessler (pictured), a principal at the firm, told PERE. “At first blush, it certainly looks like a pause to me.”
Kessler cited global headwinds, including Brexit, terrorism and financial volatility in China, which have contributed to investors’ new caution.
“When I’m talking to my clients, the fundamentals at the real estate level seem to be doing just fine,” he said. “With all of those (global headwinds) individually, I don’t think any one of them would cause what we’re seeing, but collectively they add to a general feeling of uncertainty. No one can predict when a cycle’s going to top out, but we all know this is a cyclical business.”
Commitment totals in the third quarter will indicate whether this is a short-term blip or the start of a pullback. Kessler said a total third-quarter allocation under $10 billion would point to a sustained negative shift in investor sentiment since there would have been allocation reductions in three of the four most recent quarters. However, if the third-quarter allocation were to exceed $10 billion, that would suggest an anomalous second quarter in an otherwise healthy year. Despite the low haul for fund managers in the second quarter, allocations for 2016 are on track to be the second-highest following the global financial crisis, with $20.9 billion collected in the first half of 2016 compared with $24.6 billion in the first half of 2015.
“What this data tells me is that there’s capital to be had,” Kessler said. “You can raise money if you have the right track record and the right story, and the ability to convince and show limited partners why you’re better than the rest, what differentiates you.”
Investors are also moving up the risk curve in allocations. In the first half of the year, 78 percent of committed capital went toward value-add and opportunistic vehicles, compared with 64 percent in all of 2015. Core funds saw the biggest drop, with just 6 percent in 2016 to date, compared with 29 percent of allocations in core in 2015.
“Over the last 18 to 24 months, you’ve seen a rotation out of the core category into the higher yield category,” Kessler said.
He also noted that when the firm began collecting data, core-plus funds were not a separate category, but have quickly gained popularity. The strategy garnered 16 percent of commitments in 2016 to date, compared with just four percent in 2015.