A global survey of Germany-based manager Patrizia’s investor clients reveals a stark drop-off in the proportion of respondents intending to expand real estate’s weighting in their portfolios. Over the next five years, only 17 percent are looking to increase their allocation to the asset class, down from 61 percent in the firm’s 2022 survey.
Philipp Schaper, CEO European real estate at Patrizia, says this reflects how the market has changed in the past year. “Relatively sticky valuations did not adjust to the dynamic level of shares and bonds, for example, which led to a fairly decent allocation to real estate within the broader portfolio. It is therefore understandable that, compared with last year, more investors have a more reserved view when it comes to their future allocations.”
Although an increase of 27 percentage points on the 2022 survey, the proportion of investors intending to reduce their exposure is only 28 percent. Schaper tells PERE this is a “good sign” for the asset class. “Investors have not lost hope in real estate. It will remain a significant part of their portfolios as the majority are not trying to reduce their allocation.”
Indeed, 55 percent are content to wait out the market volatility and make no alterations to real estate’s share of their overall portfolio in the meantime.
In tandem, investors expect deal activity to remain subdued for the foreseeable future. Only 18 percent of survey respondents expect transactions to increase in the next 12 months, whereas 66 percent expect activity to decline.
Schaper expects this relative market stasis will continue through year-end. “We’re about to enter the summer break season across Europe, which normally implies a bit of a slowdown in activity, and I think this will probably be even more pronounced this year. I simply don’t see the market as a whole picking up significantly in Q4.”
Time for action
Among the key findings from the survey is a shift in focus from core and core-plus strategies to debt and value-add real estate. The lower-risk strategies were the primary target for increased allocations in the 2022 study, but have since moved to the bottom of the pack, replaced by debt/real estate-backed fixed income and value-add, respectively.
As the focus moves further up the risk-return curve, investors are placing particular emphasis on where returns are driven by sustainability improvements. Among respondents, 85 percent expect brown-to-green developments to increase in the next 12 months.
“That’s where a lot of money will be made,” says Schaper. “But on the other hand, that’s also where a lot of money will be lost – simply throwing a lot of money into your assets is probably not positioning yourself to do the smartest things.” He argues it takes experience to know when a full-scale back-to-frame refurbishment is the best use of capital to decarbonize an asset and drive future value. “It’s critical you have a very good understanding of the technical and environmental requirements of your existing portfolio, and you have to understand what you need to tweak in order to achieve the right results.”
Repositioning assets in a brown-to-green strategy is therefore a “very intense business,” Schaper adds. “Is the industry completely ready for this? I would say, industry wide, probably not.”
Aside from technical expertise, a change of mindset is also required. Where previously it was common in some European markets to be able to buy an asset and sell it at a higher price two or three years later without having worked on it, the role of the manager is evolving, he says. “I think that was a very special time that we observed, but I believe we are now moving back into the asset management cycle, where active engagement on the asset side is actually paying off and proving vital for future-proofing investments and generating value-add returns.”
As part of this active approach, a much higher degree of capex spend is required. Patrizia’s survey results suggest investors are increasingly cognizant of this: 66 percent expect refurbishments/capex to increase in the next 12 months.
“For assets on investors’ books that have not been acquired in the last couple of years, and therefore where this kind of spend was not factored into the business plan, they could require further equity injection, a reduction in distributions or new loan facilities to finance these expenses,” explains Schaper, who believes this dual debt and decarbonization gap will present significant opportunities in the new cycle.
“It’s a process also for investors to understand that, in the majority of cases, sustainability-related improvements cannot be paid for by cashflow alone.”
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