Have the world’s major sovereign wealth funds had enough of real estate investing?
In its inaugural annual review published this week, The International Forum of Sovereign Wealth Funds, a global network of SWFs, talked about growing signs of “real estate fatigue.” Reading the report, the answer appears to be ‘yes.’
It highlighted a 40 percent decrease in the number of SWF investments in private real estate between 2016 and 2017. Meanwhile, the number of direct real estate investments also dropped to 42 last year from 77 in 2016.
Like other institutional investors and their managers, SWFs have been facing challenges of how and where to deploy capital at a point in the cycle when abundant liquidity is pushing high asset valuations even higher. And so they are buying fewer properties. According to the report’s findings, they purchased 17 commercial and office properties and only five luxury hotels last year, down from 25 and 11, respectively, in 2016.
Alongside today’s lofty point in the property cycle, geopolitical risk is also weighing on some investors’ minds. There is concern that US President Donald Trump’s trade war rhetoric with China is becoming a reality, with continuing tariffs on Chinese exports and China’s tit-for-tat retaliation. Tu Guangshao, president of China’s sovereign fund, China Investment Corporation, reportedly told media at a recent conference that the “unavoidable” trade war would negatively impact CIC’s investments.
Since CIC invests China’s foreign reserves, its overseas investments have not been impacted by the country’s regulator’s relentless imposition of capital controls that have significantly reduced Chinese outbound investments in real estate. In 2017, in fact, CIC posted 17.6 percent net annual returns on all overseas investments. The question is whether CIC can continue investing in the US at the same pace should diplomatic relations further deteriorate.
CIC’s state fund peers are taking notice, too, since any bilateral dispute will have global ramifications. Last week, Singapore’s GIC said in its own annual report that it maintains a cautious investment stance amid elevated uncertainty.
Though different state funds have different strategic motivations guiding their asset allocation strategy, the case for making more real estate investments may not be as robust as before, especially as real estate becomes more of a service than an asset.
Noticeably, some other state funds have also been more active sellers. According to the Q1 2018 investment report of Norges Bank Investment Management, manager of the Norway’s Government Pension Fund Global, the fund sold separate stakes in three office properties and a portfolio of logistics properties in the first three months of the year, receiving around $475 million in total. It made only one $29 million logistics acquisition – pittance for an organization with more than $1 trillion of assets.
The IFSWF report attributes fewer real estate investments as the main reason behind the overall slowdown in the SWFs’ private markets allocation last year. But the muted investment appetite could extend to alternative asset classes such as infrastructure and private equity, as well.
Most SWFs are anchored in US dollars, so the ongoing increase in the federal funds rate could make fixed-income assets like bonds more appealing for long-term investors. Moreover, the assets of many SWFs, especially those reliant on oil revenues, are not growing as significantly as before. According to a February report by State Street Global Advisors, SWF assets grew by 3 percent per year from 2014-16 versus 15 percent from 2012-14. As such, funds that face a higher probability of net outflows could find it difficult to manage their liquidity if they hold a high share of illiquid investments.
The report cautions that even though the structural shift by SWFs into alternatives investments is continuing, there are signs that these investments are about to peak and will eventually plateau.
That is the last thing private real estate fundraisers needed to read. Fundraising had already dipped some 25 percent since the cycle zenith in 2015 when $152.55 billion was raised, according to PERE data. While SWFs invest considerable equity in direct investments, they are also still considered major anchor investors in third-party funds and evidence of their fatigue just reinforces a widening view a downcycle for the asset class is now on the cards, making capitalizing on new products more challenging.
To contact the author Arshiya Khullar, email firstname.lastname@example.org