There is growing investor appetite for sector-focused core

Institutions continue to have appetite for core. But behavioral trends are seeing demand for traditional balanced funds weaken, says James Jacobs, head of real estate for Lazard’s private capital advisory group.

Jacobs: today’s open-ended core funds might not offer investors the right core exposures today

March saw continued investor appetite for exposure to core real estate. A significant number of investors adopted a cautious approach to deploying capital and were therefore making substantial commitments into core funds. This in and of itself was not new or noteworthy. The most interesting change, however, were the subdued levels of investor interest for retail and office assets.

That calls into question the role of balanced funds. Despite numerous changes to the investment landscape brought about by covid-19, the role of core real estate in an investor’s portfolio remains similar to that of previous years. Investors seeking to deploy capital into core real estate remain focused on the resilience of income, sustainability of cashflow and underlying asset quality. These investors have three priorities: larger, deeper and more liquid markets; conservative, relatively modest use of leverage; and sectors with robust demand, such as industrial and residential assets.

Traditionally, a significant number of investors would gain exposure to core real estate via large open-ended balanced funds. But the biggest constituent sectors in many of the balanced funds are offices and retail, in particular, shopping centers. The appeal of these two sectors has been reducing. There is ongoing uncertainty around the use of and demand for offices, given the economic and workplace changes caused by covid-19. Retail has seen significant disruption as a result of government lockdown measures and, more long-term, by an increase in online trade. The outcome is that both sectors are now often regarded by investors as lacking the stability required to be truly ‘core.’

The change in the way in which investors wish to be exposed to core real estate reflects altering behavioral trends. Covid-19 has accelerated some of these changes, such as the move to increased remote working and online shopping. So it is unsurprising that investors are now seeking to invest in asset classes likely to be more resilient in the modern economy such as logistics, data centers and life sciences.

As such, as we move forward in a post-pandemic world, it is likely investors will meet their exposure requirements via sector-focused funds to gain their core positions rather than the traditional balanced funds of the past.