Kohlberg Kravis Roberts & Co (KKR) has encouraged its investors to increase their allocations to real estate and, in particular, to favour opportunistic investments.
In a paper entitled Real Estate: Focus on Growth, Yield and Inflation Hedging, the New York-based private equity firm with $61.5 billion of assets under management, said investing in real estate in the current economy represented an “elegant way to own an income producing inflation hedge” and described it also as “a pure-play on financial disintermediation”.
In the paper, written by KKR’s head of global macro & asset allocation Henry McVey, the firm reiterated a currently common conviction that real estate serves as an effective inflation hedge given widely low interest rates, which the firm expects to continue for the next few years.
“Our research shows that if we are wrong and rates do rise more than our current expectations in the near term, cap rates might be less vulnerable to this sort of ‘shock’ than some investors currently believe,” it said.
KKR recommended to investors to increase their allocations to real estate to 5 percent of their total assets from its previous recommendation of 3 percent, sacrificing allocations to gold, corn and other commodities in the process to “pay for this additional exposure”.
But KKR warned that while real estate generally would provide investors with yield, growth and investment hedging, asset selection remains key particularly given many of the world’s prime markets are now “fairly valued and, in some cases, outright expensive”.
“By comparison, we believe there are compelling investments in the non-core and opportunistic segments of the real estate market that can provide investors with a more attractive risk-adjusted return profile. The key is to understand which locations will benefit from secular growth drivers in employment, including manufacturing re-shoring, oil and gas exploration, education and technological/healthcare advances.”
KKR emphasised how a large and growing opportunity to invest in real estate stemmed from widespread deleveraging as traditional lenders have to curtail their financing programmes. “Further enhancing this opportunity is the disappearance of the shadow banking system, as well as tougher standards administered by the credit-rating agencies.” The firm singled out Europe as having deleveraged less than the US but said the region is on the cusp of being forced to accelerate loan dispositions.
“Our advice for the future: Given the diversity of opportunity sets we see ahead we think having as much flexibility as possible to deploy capital, including the ability to provide equity, mezzanine, or even traditional loans, across a variety of industries and locations is likely to be a critical input to driving strong returns in the asset class,” KKR said.
Tellingly, KKR warned investors which are considering investing in real estate via the REIT sector to heed various warnings including: their correlation to other financial stocks; that listed REITs represent a small constituent of the real estate universe making it hard for institutional investors to deploy capital at scale.
KKR has since 1976 grown into one of the world’s preeminent private equity firms but broke into direct real estate investing only recently at the start of 2011.
The firm has yet introduce its own investment fund but has put balance sheet capital to work in a small number of transactions. Earlier this month it was announced that the firm is taking part in a $130 million joint venture investment in the management company of senior living specialist Sunrise Senior Living. That followed its first US retail real estate investment in April, the $196 million JV capture of the Yorktown Center in Chicago. KKR has also jointly raised a small fund for Chinese development investments with Sino-Ocean Land, one of Beijing’s largest real estate companies, a year ago.
While the firm can use third-party capital from its various divisions, it is has allocated $300 million from its balance sheet specifically for real estate investments.