Investor interest in value-add and opportunistic strategies has been rising over the past half-decade, but the percentage of institutions targeting core real estate has started to fall, according to the 2018 Institutional Real Estate Allocations Monitor.
The annual report by Cornell University’s Baker Program in Real Estate and New York-based placement and advisory firm Hodes Weill & Associates surveyed 208 institutional investors from 30 countries, with nearly $11 trillion in total assets and approximately $1 trillion in aggregate real estate assets.
It found that Investors had the strongest preference for value-add real estate, with 90 percent of respondents reporting they are actively allocating capital to the strategy this year. This is up from 87 percent in 2017 and on a steady uptick since 2014, when 74 percent favored value-add. Opportunistic strategies also attracted growing interest from investors, with 75 percent of survey participants targeting the risk-return profile in 2018 – an increase from 72 percent in 2017 and 57 percent in 2014.
By comparison, investors have retreated from core real estate, with approximately 63 percent of institutions targeting the strategy in 2018 – down from 69 percent in 2017. The decrease marked the first time since the survey’s 2013 inception that it has reported a decrease in the percentage of institutions investing in any strategy. “This may be attributed to investors’ belief that we are late in the cycle, and that cap rates are more likely to increase versus decrease over the coming years, especially when/if interest rates rise,” wrote the report’s authors, led by Dustin Jones, director of the Baker Program, and Douglas Weill, managing partner at Hodes Weill.
The pullback from core has been most pronounced in the Americas, where interest in core strategies decreased from 63 percent in 2017 to 50 percent in 2018, while 95 percent are actively targeting value-add investments. “This is likely based on concerns about valuations peaking, driven in part by an influx of foreign capital in recent years into major North American real estate markets,” the authors said. “The increased competition for core products in these markets have driven up asset values and forced institutions to pursue core opportunities in secondary markets in an effort to find more favorable risk-adjusted returns.”
By comparison, institutions in Europe, Middle East and Asia-Pacific continue to favor core real estate investments and are much less likely to invest in higher-risk, higher-return real estate.
While value-add and opportunistic strategies are favored by all investor types, interest in core real estate showed far greater disparity among institutions. Only 36 percent of endowments and foundations were targeting the strategy, compared with 78 percent of public pensions and 100 percent of sovereign wealth funds and government-owned entities, according to the report.
Interestingly, by geography and investor type, risk preferences were correlated with returns in the asset class over the past five years. In the Americas, where interest in higher-risk, higher-return strategies was strongest, returns have been on the decline, with an actual five-year average of 10.9 percent, an actual three-year average of 9.8 percent and an actual 2017 return of 9.1 percent, the survey stated. By contrast, returns have moved in the opposite direction for both European and Asian investors.
Moreover, Americas investors are pursuing the highest returns among the three regions, targeting 8.5 percent in 2018, compared with 7.3 percent for their European counterparts and 8.1 percent for Asian institutions. Americas investors have maintained the same return target for the past three years, whereas European investors targeted 6.9 percent in 2017 and 8 percent in 2016, while Asian investors lowered their targets from 8.8 percent last year and 8.4 percent in 2016.
Among investor types, endowments and foundations are targeting the highest returns for 2018 with an 8.8 percent goal, compared with 7.6 percent and 7.2 percent, respectively, for more core-friendly public pensions and SWFs and GEs, the report showed.