Institutional investors’ declining confidence in real estate is driving them to invest in debt products and other defensive strategies, according to the fifth annual “Institutional Real Estate Allocations Monitor” from Cornell University’s Baker Program in Real Estate and Hodes Weill & Associates.
“Absolutely the issue of conviction is slowing down commitments to investment strategies”
– Doug Weill
In this year’s report, the investor conviction index dropped to 4.9, or “slightly pessimistic,” reflecting respondents’ views of the investment opportunity in real estate from a risk/return perspective on a scale of one to 10, with one being the least favorable and 10 being the most favorable. The low conviction rating represents a continuing decline from 6.4 to 5.4, or “moderately optimistic,” between 2013 and 2016.
Investor concerns include too much capital pushing valuations ahead of fundamentals, the risk of rising interest rates, global capital markets volatility and geopolitical risks – the same issues cited in 2016.
“Absolutely the issue of conviction is slowing down commitments to investment strategies,” Hodes Weill co-founder Doug Weill told PERE. “What we’ve seen is that as target allocations continue to rise, and as the percent invested continues to lag, there’s pressure on institutions to deploy money, so they’re turning to more defensive strategies. For example, they’re looking at credit funds. We had a count of 90 different debt funds that are open and on offer, which is staggering.”
About 60 percent of survey respondents reported investing in debt strategies, up from 52 percent last year. With the number of debt products on the market, however, Weill said many managers are unlikely to reach their fund size targets.
“It’s not easy to hang a shingle and say we have a debt product. You really need an accredited team that has a history of originating loans through cycles,” he said. “Of the 90 offerings in the market, there are a fraction of those that are fully-scaled lending businesses. Even though there are so many offerings, they’re not all going to be successful.”
Despite diminished investor confidence for real estate, allocations to the asset class continue to climb. This year, the sector has broken the 10 percent threshold for institutional portfolio allocation, with the average allocation now at 10.1 percent, up 20 basis points from 2016 and up approximately 120 basis points over the past four years. Overall, 24 percent of investors boosted their target allocations in 2017, compared with just 5 percent that decreased their allocation targets.
“We’re starting to hear from institutions that are thinking about real estate as a target allocation that could be 15-20 percent of their portfolio, not 10-15 percent,” Weill said, citing a recent discussion with an unnamed public pension chief executive officer set to recommend his board increase its real estate allocation from 15 percent to 20 percent.
Such a pension may be an anomaly, however. Generally speaking, the steady rise in real estate allocations in recent years appears poised to reverse in the near term, primarily because of waning investor confidence, Weill said.
In addition, the percentage of investors allocating money to private equity real estate funds has risen significantly over the past year, with 87 percent of institutions actively investing in funds in 2017, up from 79 percent in 2016.
“We’ve spoken to endowments that, 12 to 24 months ago, weren’t looking at funds but now are,” Weill said. “And we talked with some other major investors that were doing joint ventures but have the weight of capital and are looking to funds. The need to deploy money is there: it’s an illiquid asset class and it’s hard to transact on a direct basis, so use of the closed-end funds is going up. It doesn’t mean that capital is going to skyrocket.”
This year’s Allocations Monitor was derived from research collected from 244 institutions in 28 countries. Participants hold total assets under management of $11.5 trillion, with aggregate real estate investments of $1.1 trillion.