The gap between how much capital institutions have set aside for real estate and how much they have actually invested in the asset class has never been wider.
The weighted average target allocation to real estate is now 10.7 percent, according to a survey of investors conducted by New York-based capital adviser Hodes Weill & Associates, up from 10.6 percent last year. Meanwhile, the average actual allocation is 9.3 percent. This is the largest disparity since the firm began releasing its annual Allocations Monitor nine years ago.
Investors who responded to the survey collectively own $13.4 trillion of assets, including $1.2 trillion of real estate. An increase of 140 basis points would translate to an additional $187 billion for the asset class. While that type of deluge is unlikely, Hodes Weill co-founder and managing partner Doug Weill said the gap between target and actual allocations to real estate will be meaningful for fundraising in the months and years ahead.
“We’re always careful to not suggest that much capital would get put in the market because that number does bounce around a bit due to the denominator effect,” Weill told PERE. “But directionally, it’s a big number, wider than we’ve seen since we started the survey and also consistent with what we’re hearing when we talk to institutions. They’re underinvested and playing catch up.”
Historically, actual allocation has lagged target allocation by 60 basis points to 110 basis points. Weill attributes the ballooning under-allocation identified in the report to three factors. The first is the fact that investors slowed down their pace of deployment during covid-19. Only 72 percent of respondents said they were actively investing in real estate, tying 2014 for the lowest rate recorded by the survey, and 13 percentage points below 2020.
The second factor is the denominator effect. As public equities markets continue to climb in value, real estate holdings are making up a relatively smaller share of investor portfolios. Weill noted that unlike other periods when actual allocations significantly lagged their targets, confidence in the asset class is high. On a scale of 1 to 10, respondents registered a 6.5 on Hodes Weill’s in-house “conviction index,” the highest rate notched since the survey launched.
“At points in time when the margin of underinvestment has been wider, there wasn’t this level of positive conviction in the market,” he said. “The combination of the two suggests we’ll see continued flows into the asset class.”
The third factor is simply that investors want more real estate. This is particularly true in the Asia-Pacific region, where the gap between target and actual allocation is even wider than the global average at 290 basis points. Weill attributes this to the fact that institutions in this region have not been building their exposures to the asset class for decades as their peers in North America and Europe have done.
“Many Asia-based institutions are new to allocating capital to private market real estate investments, so they’ve set allocations and they’re off to the races,” Weill said. “We attribute this to new entrants and new allocations to real estate.”
Asian institutions are also leading a resurgence in cross-border investing, with 95 percent of respondents from that part of the world saying they would invest outside of their home region, up from 80 percent in 2020. In comparison, 63 percent of investors from the Americas said they would do the same, up from 60 percent the year before. Institutions in Europe, the Middle East and Africa still have the greatest domestic bias, with only 55 percent saying they would invest abroad, down from 66 percent in 2020.
Overall, Weill sees two schools of thought emerging within global investors, and he expects both to have positive implications for the fundraising market.
“Fundamentals are strong, asset values are performing well and the fear that there would be a huge devaluation broadly has abated,” he said. “So, on the one hand there’s an expectation of distress and dislocation. On the other hand, investors feel really good about their portfolios because they bounced back strong in 2021.”