In Spite Of Its Problems, Big Global Investors Still Want To Pour More Into Real Estate — $100B More

The world’s biggest institutional investors are nervous about investing in real estate. It is late in the cycle, asset prices are high, interest rates are rising and there is ever-present geopolitical risk. But in spite of that, this year, they want to put even more into the sector.

That is the slightly counterintuitive finding of the 2018 Institutional Real Estate Allocations Monitor produced by real estate capital advisor Hodes Weill, which surveys 208 investors from across the world which have $11 trillion of assets.

For the past four years, the amount these investors want to put into real estate has been rising, but their conviction about whether this was the right bet was waning — the conviction index Hodes Weill produces fell by 30% between 2013 and 2017.

In 2018 that conviction index ticked up slightly, after investors achieved strong real estate returns in 2017. As a result, after Hodes Weill predicted last year that investor allocation intentions would be flat in 2018, they rose. The average institution now wants to allocate 10.4% of its assets to real estate, compared to 10.1% last year. Hodes Weill expects that figure to rise to 10.6% next year.

Given the average allocation to real estate is currently 9.5%, that means global institutions want to put another $100B into real estate over the next few years.

The report said the rise in conviction “comes as a bit of a surprise, as investors continue to cite concerns regarding rising interest rates, asset valuations, and geopolitical risks, in addition to the perception of being late in the cycle (i.e., 'late innings' for baseball fans)”.

“The investment world is a juggernaut, and it can take a while for it to slow,” Hodes Weill partner Will Rowson said. “Returns went up in 2017, which is one explanation. People can be sitting there nervous about a lot of factors, but the returns stay healthy, so you start to think, maybe I shouldn’t be so nervous.

“Also, real estate is an outlier in terms of returns compared to bonds and equities, and investors can’t help but be influenced by that.”

Of course, not every investor is confident and looking to increase its real estate exposure. The overall global rise in allocations was driven by investors in Europe and Asia — U.S. investors on average said their allocation was going to be flat. And among U.S. investors, university endowments wanted to decrease their exposure to the sector by an average of 130 basis points. The report noted university endowments tend to be "absolute return" investors, meaning they don’t just compare the different sectors when making allocation decisions, and so real estate did not look as compelling for them.

Sovereign wealth funds also said they were going to decrease their exposure to real estate by an average of 30 basis points.

“U.S. investors have been hearing for a long time that we are late in the cycle, and so they don’t want to get it wrong at this point,” Rowson said.

The increase in appetite from European and Asian investors is being driven by insurance companies, who have historically been underallocated to the sector. But not much of this capital will be heading for the U.S., Rowson said. The strong dollar means that it costs non-dollar-denominated investors around 300 basis points to hedge currency risk, severely affecting the returns they can achieve.

To avoid paying high prices for assets that can’t be improved late in the cycle, investors are showing a clear preference for value-add strategies, particularly U.S. investors, the report showed. Among all investors 90% said they were investing in value-add strategies, compared to just 63% for core strategies, a figure that fell from 69% in 2017.

Looking specifically at the U.K., Rowson said raising capital for investment in all but a few sectors, such as rented residential or logistics, was difficult at the moment.

“Brexit makes it hard to explain to investors what your strategy needs to be,” he said.