Investors are boosting their real estate allocations – as they should

PERE’s latest investor report prompts the notion that more investors should be dialing up their exposure to the asset class while the market resets.

PERE’s H1 2023 Investor Report reveals average real estate allocations increased for all institutional investor types: foundations and endowments, private pension funds, public pension funds, insurance companies and sovereign wealth funds.

Such a universal climb for average allocations has not occurred across all investor categories in the last five years. Sovereign wealth funds were one investor type, for example, that saw declining allocations to real estate from H1 2019 to H1 2022, for instance, the research demonstrates.

To what degree the denominator impact is behind this wholesale average increase would be interesting to understand. Further, it would not be hard to understand why investors might, in fact, want to maintain or even decrease their real estate allocations, given the asset class has delivered a negative return for many lately.

Examples of this negative return come from America’s west coast where California Public Employees’ Retirement System and California State Teachers’ Retirement System recorded -3.1 percent and -0.5 percent real estate returns, respectively, in the 2022-23 fiscal year.

Norges Bank Investment Management, steward of Norway’s sovereign wealth fund, is another example. The firm posted a -14.1 percent loss for real estate in 2022, with unlisted real estate investments returning 0.1 percent and listed real estate investments, -30.8 percent.

But NBIM’s chief executive officer Nicolai Tangen said in a Bloomberg TV interview last week the institution would stay the course in real estate, undeterred by the negative performance or the widespread “bad news” about the sector. As for many state investors, his is the long-term view.

There is an obvious sense to Tangen’s words. Furthermore, NBIM and others have an opportunity to capitalize on any corrections happening in real estate markets over the next few years so maintaining, or even increasing, allocations has to make sense.

Indeed, investment performances can change very quickly. Case in point: real assets were among CalPERS’s best-performing asset classes in 2022, returning 24.1 percent. A world of difference to just one year later.

Jeffrey Perlman, president at New York-based Warburg Pincus, which owns Singapore-headquartered manager ESR, agreed on the manager’s earnings call this week that real estate investors should continue to be active through the downturn, noting how those waiting until the market has fully recovered could find themselves with suboptimal returns.

Investors that concur with Tangen and Perlman are likely to find a less competitive landscape if they do keep actively deploying. According to research by broker JLL, direct investment declined 54 percent globally year-on-year during Q2 to $139 billion, bringing first-half volumes to $276 billion. That is the lowest first-half level in a decade and a notable hole that needs filling.

As such, investors maintaining or decreasing their real estate allocations would benefit from a rethink if they harbor long-term aspirations – which many do. Wisdom would thus dictate it would be better to be putting more capital to work while the competition for assets is lower.