With concerns of trade wars easing and Brexit’s finale coming into focus, global investors are continuing to allocate capital to the real estate asset class, buoyed by relatively strong fundamentals, low interest rates and healthy job formation. Investor sentiment for the asset class has been trending upward after several years of declines, as reported in our 2019 Institutional Real Estate Allocations Monitor.
Capital continues to target a broad range of asset types, geographies, risk strategies and investment structures. Investors remain cautious, which may be contributing to the duration of this long cycle, seeking strategies with a significant current yield component and a lower correlation to GDP.
We are still seeing large inflows into private real estate funds and, as in years past, much of this new capital was committed to a handful of the largest real estate fund managers. To put numbers around this point, with over 900 private closed end funds trying to raise capital last year, 11 private real estate funds accounted for 45 percent of the total funds with final closings in 2019.
As the cycle continues, the story seems to be the same, so what’s new? Undoubtedly (and importantly), investors are increasingly focusing on environmental, social and governance issues as part of their diligence and investment decision-making process.
This trend has been ongoing particularly with European and Australian investors, but North American investors are catching up and implementing their own policies and focused diligence as well. These issues may have a broad reach into many areas of managers’ organizations.
We are seeing more ESG-focused DDQs from investors and consultants, as well as side letter language strongly encouraging participation in the GRESB or other similar performance surveys. Investors want to know that their selected managers are operating and developing investment portfolios with sustainable objectives in mind and also viewing climate risk as an additional layer of fiduciary responsibility.
Investors expect their managers will take the lead in monitoring the potential impact climate risk has on their portfolio. Given that this is an evolving area of focus, investors accept that managers don’t have all the answers, but they want to see concrete steps to move in the right direction.
Beyond environmental considerations, the ‘S’ and ‘G’ are increasingly in focus as well. For example, we note that investors and consultants are poring over organization charts noting the number and responsibilities of women and minorities on the page. Are they in leadership roles in the firm, and not just in IR and legal and accounting functions? This is not a new issue, especially for the real estate industry, but investors want to know what steps managers are taking to build the bench.
“Investor sentiment for the asset class has been trending upward after several years of declines”
Another trend we are seeing, and this is not surprising given the industry is maturing, is that succession planning has become a key topic among leadership teams, and many are evaluating strategic options for their platforms as founders transition away from the business. One such option may include the selling of a strategic stake in the business, which provides some monetization for the retiring partners, but is often a necessary catalyst to transition ownership to the next generation of partners.
We have seen a sharp increase in the volume of transactions over recent years and we expect this to continue. Investors are frequently tasked with consents and want to make sure the culture, the investment process, the strategy and the product offerings do not significantly change. Investors are thus focusing more on succession issues, too, and want to ensure the proper alignment is in place for the remaining team.
Note: This commentary was written prior to the outbreak of coronavirus, which has since severely impacted real estate markets worldwide.