Hodes Weill: ‘The denominator issue is abating’

Over 80% of institutions in the capital advisory firm’s latest Allocations Monitor are now actively considering fund investments.

For the third consecutive year, the percentage of institutional investors overallocated to real estate has continued to grow, according to Hodes Weill’s 2023 Real Estate Allocations Monitor. In fact, nearly 40 percent of institutions were overallocated to real estate by an average of 200 basis points in 2023, compared with 32 percent in 2022, the report showed.

However, overallocation is expected to become less of an issue going forward as institutional real estate portfolios begin to rebalance. “The denominator issue is abating,” Doug Weill, founder and co-managing partner at the New York-based capital advisory firm, told PERE. “It was really the beginning of the fourth quarter [of 2022] when you started to see write-downs,” he said. “At the same time, public equity started to bounce back. And so that’s what’s bringing us back to balance.”

Weill: institutional real estate portfolios are beginning to rebalance

Weill expected the abatement of the denominator effect to continue for the foreseeable future, assuming public equities and other allocations remain flat and write-downs in private real estate are ongoing. “Some have said it’s a couple of quarters of additional write-downs,” he noted. “Even if you tread water with where public equities are, if we continue to see write-downs, that’s going to have a meaningful effect on actual allocations.”

Another driver of allocation and capital flows is market sentiment. “Even if investors had capital today, I think they’re still very cautious about what’s going to happen over the next few quarters and concerned about putting money into the market too quickly, when the market is continuing to reset,” Weill said.

That said, investor conviction is on the rise. Indeed, on a scale of one to 10, with one being the least favorable, survey respondents rated their view of the investment opportunity in real estate at an average of 6.4 points, marking the second-highest level of conviction reported since 2013. “This increase in conviction suggests that investors are increasingly optimistic about returning to the market and deploying capital, after sitting on the sidelines for much of the past 18 months,” the report stated.

Despite the currently sluggish fundraising environment, over 80 percent of institutions are now actively considering investments in closed-end funds, reversing a three-year decline and up from 74 percent in 2022.

“We’re seeing a lot more engagement with institutions and consultants, and that’s a signal that they’re starting to consider investments again,” Weill said. “But no one’s in a particular rush to put capital out.”

Dry powder in the market also remains quite high, he added: “We’ve heard from a number of institutions and consultants that if you look at this year, they’re continuing to get capital calls, and they’re not getting a lot of distributions.”

The fundraising environment therefore will be correlated with transaction volumes, because as managers start selling assets and returning capital, new investor commitments will concurrently start to rise.

“I think we expect a meaningful pick-up in ‘24,” Weill predicted. “But I don’t think we would say it’s going to be off to the races.”