The Perspectives 2020 survey found 35 percent of investors plan to increase allocations to private real estate this year, while 32 percent are under-allocated to the asset class. These desires form part of a trend toward more investment in alternatives: 40 percent of respondents plan to increase the proportion of their portfolio allocated to alternatives by more than 5 percent. A majority of investors also plan to maintain their average commitment size, with a significant minority seeking to increase.
Kiran Patel, chief investment officer at Savills Investment Management, says: “It doesn’t surprise me that there’s still an underweighting toward real estate. Most models suggest higher allocations to real estate, even as actual allocations have risen from 4-5 percent to 10 percent. However, the models will continually show higher, and that is down to real estate’s stable income and diversification characteristics.”
Alfredo Lobo, partner at real estate advisory firm Hodes Weill, adds: “The continued popularity of real estate with investors is not surprising in the current low interest rate environment, with lower than expected fixed income returns. We find that increasingly CIOs tend to view real estate as a fixed income alternative.”
Real estate’s popularity is also linked with its performance. The survey found close to 90 percent of respondents who invested in real estate had met or exceeded their benchmarks. Patel says: “Benchmarks have adjusted to the low interest rate, low inflation environment. So real estate has performed as expected, but people have also adjusted their expectations.”
Steven Cowins, a fund formation specialist at law firm Greenberg Traurig, adds: “With interest rates and government bond yields being where they are, it is not surprising that anyone holding assets has met or exceeded their benchmark. It’s difficult to see now why this low interest rate environment will change. However, this applies to historic assets – the real challenge is making new investments in this economic climate which can meet your target returns.”
While most investors polled for the survey are holding steady with their real estate strategies, planning to invest much the same as last year, there is also an inclination to take on more risk in the search for higher returns. The survey findings show a trend toward value-add and opportunistic strategies, with 30 percent and 23 percent of investors keen to invest more in these strategies, respectively. There is also strong interest in investing opportunistically in real estate debt.
“Given there is little to no yield compression left in most sectors, the main ways of seeking to achieve higher returns are value-add and opportunistic strategies, in particular development, where planning gains drive the performance,” says Cowins.
However, Patel says: “A lot of insurance companies and pension funds have guaranteed liabilities to meet in this low interest rate environment, so are seeking to enhance returns from real estate. Also, as institutions become more familiar with real estate, they become more comfortable with moving up the risk/return curve. That said, I don’t believe there is widespread appetite for more planning risk or construction risk, or other strategies that would significantly increase volatility.”
An eye on the red flags
The three most significant threats to performance currently playing on investors’ minds are a possible recession in core markets, cited by 72 percent polled for the survey; the US-China trade war, which is a concern for 61 percent; followed by extreme market valuations. Patel comments: “Capital markets are very much interconnected, so factors such as the US-China trade war cannot be ignored. It is important to assess the secondary and tertiary effects on portfolios. There are other trade issues to come with Brexit, and in geopolitical terms the Middle East situation is one to watch – oil prices are an important inflationary factor in markets where oil is largely imported.”
Cowins argues it is “difficult to see which macro event could unsettle the markets, but this is the definition of trying to predict a black swan.” However, he notes that: “Given the limited amount of product and the pricing driven by low interest rates and a dysfunctional bond market, the real risk is managers lose their discipline and overpay for assets.
“The real problem is it is difficult to see where a recession could hit and whether it will be market-wide or whether we will have mini cycles in the market, such as we have now with retail continuing to fall, but logistics and industrial are having a boom.”
Investors were also asked if they see evidence of style drift from their managers. While only 5 percent said they saw widespread evidence of this, a further 68 percent said they saw only occasional examples.
“We do not see evidence of style drift among real estate investment managers,” says Lobo, “although they may add capabilities, as for example a number of managers have launched Asia-Pacific core strategies in recent years. We find investors are happy with managers of value-add or opportunistic strategies moving into the core space, but not so keen on movement in the opposite direction.”
Cowins adds: “The private equity real estate managers I act for are extremely disciplined and I don’t see style drift.”