Real estate markets face an unprecedented set of risks during 2017, and this is likely to lead to greater caution by investors, and challenges for managers in raising capital. Despite this, real estate remains a favored asset class, as confirmed by a series of eight roundtables held towards the end of 2016 by bfinance in France, Italy, the Netherlands, Sweden and the UK. These meetings, with more than 50 investors, demonstrated the critical need for a bespoke approach and provided a series of specific insights for managers seeking to raise capital during 2017.
One of the fundamental insights was the uniqueness of investor requirements. There are many different types of investor, in terms of scale, capital base, regulatory context and risk appetite. These differences can help understand the potential to attract investors to specific strategies. For instance, cultural and regulatory factors mean Dutch and Swiss investors are far more sensitive to fees than, say, US investors.
But even among similar types of investors there are important differences in the history, funding status, portfolio structure and personnel of every investor. Although unique, all investors face common challenges, and an understanding of that can help managers explain the relevance of their investment programs. On the one hand, they all operate in the same global macro environment. On the other, they move through a broadly similar investment process. Let’s look at these two important challenges in turn.
First, real estate markets face an unprecedented set of risks in 2017. Most markets have become aggressively priced, perhaps not when compared with bond yields, but certainly historically, and very likely in the context of rising rates in countries such as the US. This aggressive pricing coincides with massive government indebtedness and greater macro uncertainty, mostly related to geopolitical risks, whether associated with the new US administration, the elections in France, the Netherlands and Germany, the Brexit process, terrorism and other issues. Within this context, it is likely there will be greater caution from investors. There will be particular focus on risk mitigation and diversification. Risk mitigation might involve specific types of investment strategies (such as real estate debt that might provide some resilience in the event of a downturn) or the ways in which specific investment programs (whether core, value-add or opportunistic) are prepared to withstand and exploit any downturn. Although there is pressure to reduce the number of manager relationships and avoid strategies where there is a heightened risk, diversification will become more important, in terms of geography, style, manager and vintage year.
If all investors face these risks, managers can help them understand how specific investment strategies can be suitable given the heightened uncertainty. In communicating this, managers should engage throughout the investment process. There are three areas I would suggest for specific attention.
Firstly, there is the role of real estate in their portfolios. Real estate can play many roles: as a bond substitute or as private equity as a subset of the equity market. Particular themes for 2017 include risk, return, liquidity and the potential impacts of macro shocks on performance.
Secondly, as governance and regulation increases for most investors, themes for 2017 include specific regulatory compliance – whether formal, such as AIFMD or MIFIDII, or informal, such as ESG considerations – and high levels of transparency and communication.
Thirdly, there is implementation, or the specific process for allocating to strategies and selecting managers. Investors are increasingly looking for transparency on the strengths and weaknesses of managers in terms of the strategy, team, corporate activity, alignment, pipeline and fees.
Although 2017 is likely to be a year of uncertainty, our roundtables revealed an overwhelming desire for broader and deeper real estate exposure from most investors. Uncertainty will increase wariness, but this should be an opportunity for managers to demonstrate their specific strengths and their potential relevance to every unique investor.