Invesco: Sovereign wealth funds shift away from real estate

The asset class has become less attractive than private equity and infrastructure due to the challenges in office and retail.

Real estate has become the least attractive private asset class for sovereign wealth funds due to challenges in the office and retail sectors.

Real estate accounted for 8.0 percent of sovereign wealth funds’ portfolios in 2023, representing a 1.2 percent drop from 9.2 percent in 2022, according to Atlanta-based investment manager Invesco’s Global Sovereign Asset Management Study 2023. Property also saw the biggest allocation decrease among the major alternative asset classes: the allocation to infrastructure rose from 4.9 percent to 7.1 percent over the one-year period, while private equity held steady at 7.4 percent, compared with 7.5 percent the previous year.

Investors remain cautious toward real estate as net allocation intentions in the asset class dropped from 23 percent in 2020-22 to 9 percent in 2023. The report noted real estate is currently perceived to be less attractive than private equity and infrastructure due to the disruption in traditional real estate sectors such as office and retail.

While office and retail are two of the least attractive classes, many sovereign wealth funds are heavily exposed to the former. They are consequently looking to “navigate” the changing real estate landscape and rebalance their portfolio by diversifying into more attractive sectors such as industrial and healthcare. “We have considerable office exposure and aim to diversify by acquiring more residential and alternatives like self-storage and logistics,” said a Middle Eastern investment sovereign in the report.

Having said that, some investors still see opportunities in office as price correction and under-investment in the sector kick in. Indeed, 63 percent of Asian investors still have a strong interest in office, the study showed.  “We’re increasing real estate allocations. The short-term office pinch will be followed by a gradual return. The lack of construction and underinvestment in the next two years will create better opportunities in 2024,” a Western liability sovereign remarked in the report.

In addition, the increase in debt levels caused by interest rate hikes has also become an important consideration for institutions investing in alternatives such as real estate. Almost half of sovereign wealth funds in the survey are shying away from real estate, private equity and infrastructure deals due to unappealing debt structures. A total of 52 percent of investors reported a higher debt level than three years ago in real estate, compared to 50 percent in private equity and 45 percent in infrastructure.

However, while real estate has generally become less favored among sovereign wealth funds, credit remains a popular strategy. With the increase in interest rates having significant boosted the expected return in fixed income, real estate debt is considered to be the third most attractive type of alternative fixed income behind emerging market debt and high yield.