The question of 'what inning we are in' was not the right question for institutions and the consultants which advise them, a panel of investors discussed at PERE Summit: New York.
Accepting the majority of private real estate markets are in the latter stages of their cycles, four panellists on an investor panel at the event, speaking on condition of anonymity, said they were in preparation mode for a coming downturn, no matter when it comes.
One investor discussed the challenges of preparing his chief investment officer for the strategy of exchanging lower returns for downside protection. That panelist's real estate portfolio, which has had “a relatively long period of high-teens and 20s returns,” will likely see low double-digits returns through any downturn, he said.
“We think we should be able to generate a 12 [percent return] and we think that's phenomenal compared with the other asset classes we're investing in,” the panelist said. “But one way we position ourselves [for a down cycle]…is by not making binding allocations to existing investors so we have the flexibility to move quickly.”
Other panelists echoed this risk-off mentality through a number of strategies. Two of them said they were net sellers this year, shedding assets while prices were still high. One was doing more direct deals to retain control, avoiding new fund commitments, and the other was focusing on deleveraging and building up a cash reserve ready to deploy when prices fall.
“Maybe [our dispositions] still had life in them, but I don't want to wait until nobody will buy them,” the investor said. “We're not all falling off the cliff at the same time. Having that cash gives us the opportunity to make those investments.”
However, one pension consultant noted his clients were not generally net sellers. After the financial crisis, he said his clients have been more focused on understanding their assets better. Many suffered during the global financial crisis, he said, because they did not understand the geography and leverage composition of their portfolios. Subsequently, he has advised them to focus on the durability of cash flow; how accretive leverage was to income; and the staying power of tenants through a correction.
Despite more traditionally equity managers raising real estate debt funds currently, the panelists largely rejected that strategy, arguing that it exposed them to too much risk. Instead, the two investors said they were seeking demographically-driven property types, such as student housing. The consultants echoed that investment strategy, noting they liked long-term, scalable assets such as student housing, but also data centers and medical offices.
“If you're doing generic suburban or CBD office, you're taking a significant amount of GDP risk,” one investor said. “Student housing didn't get hit [in the GFC] on a fundamental basis because kids kept going to college.”