Institutional Investors Eye CRE Valuations As Market Whipsaws Continue
As public equities-laden pension funds reel from massive hits leveled by stock market volatility this year, commercial real estate will likely continue growing in importance for institutional investors in the long term, experts say.
In the short term, however, new equity deals from institutional investors have slowed, and many deals underway prior to the coronavirus pandemic have fallen by the wayside. About 90% of such organizations have seen deals fall through because of the coronavirus, according to an April survey from the Pension Real Estate Association.
In addition, about 70% of investors are at least temporarily scaling back investments in commercial real estate as a result of COVID-19, the disease caused by the coronavirus, according to PREA, which recorded answers from over 70 different institutional investors and investment managers responding between April 9 and April 14.
Institutional investors' appetite for CRE leads to trillions of dollars of investment in the sector each year. In 2018, for instance, the 500 or so largest institutional investors allocated $2.53 trillion to real estate, according to data from Preqin.
This year, a date many are looking to is June 30, according to RCLCO Senior Managing Director Taylor Mammen, who serves as the firm’s director of institutional advisory services.
"Everybody is now looking forward to 6/30, which is the next time real estate is really going to be valued, to determine what real estate allocations [are] on a percentage basis, and therefore how much capital is available to invest in real estate," Mammen said.
Pension funds will likely mark down values of their CRE holdings, allowing them to rebalance their allocations in the sector by investing more, often at discounted prices, said Mammen, whose company works with large institutional investors like the California State Teachers' Retirement System and Arizona State Retirement System.
An alternate (and less likely, according to Mammen) outcome would be pension funds keeping CRE values relatively stable, as they largely did at the end of March in the face of the uncertainty caused by the coronavirus.
In that case, with stocks still well below their highs and real estate virtually unchanged, funds would probably have less to invest in CRE because of the denominator effect, according to Mammen.
With another quarter to evaluate the effects of the corona virus and COVID-19 on real estate, CRE asset markdowns are more likely than not, Nuveen Managing Director Wendy Pryce said. For now, 70% of respondents in the PREA survey said asset appraisals "may contain material uncertainties," versus 0.8% who said they are as accurate as ever.
“Quite frankly, most of the March valuations don’t really reflect the potential gravity of the situation," Pryce told Bisnow.
In either case, CRE's function as an income-producing diversifier for portfolios will keep it in high regard, both Mammen and Pryce predict. As an asset class that gets revalued quarterly, CRE adds stability, Mammen said.
Income-production, too, will keep CRE a mainstay in the portfolios of pension funds, which rely on it to pay out benefits, Pryce said.
“Investors have a place for [CRE] in their portfolios, particularly pension funds doing asset-liability matching," she said.
That place for CRE in institutional investors' portfolios has tended to grow in recent years. Weighted average target allocations to the sector have risen steadily since 2013, from 8.9% that year to an expected 10.6% this year, according to the latest survey from Cornell University’s Baker Program in Real Estate and Hodes Weill & Associates.
"There's been a long-term trend among institutional investors to grow their real estate allocations," Mammen said. "I think that only continues coming out of this."
Last fall, two of the largest pension funds dove more deeply into real estate, with CalSTRS increasing its target allocation from 13.9% to 15%, National Real Estate Investor reports.
Both the California Public Employees' Retirement System and CalSTRS declined to comment on their outlooks on CRE for this story.
Hawaii Employees' Retirement System, a midsized public pension fund with a real assets target allocation of 8%, isn't changing much yet in its real estate portfolio, Hawaii ERS Chief Investment Officer Elizabeth Burton said in an email to Bisnow.
"At the moment, we are staying the course with respect to our investments and have no major strategy changes at this time," she said.
Some investors have begun exploring ways to capitalize on market changes that come out of the coronavirus crisis. For the rest of this year, that likely means some institutional investors snatching up distressed assets, Mammen said.
Beyond 2020, investors will focus on changes potentially resulting from the pandemic, like an interest in data centers or wellness-oriented multifamily properties, he said.
"The first couple of weeks of lockdown had really more of a deer-in-headlights effect" both for managers like Nuveen and their partners, Pryce said. Since then, investors have started looking for opportunities more quickly than they did following the onset of the last recession, she said.
Square Mile Capital CEO Craig Solomon said there is a move away from core investment in open-ended funds, as they are closed to redemption because of steep drops in value.
"It won’t be until after the second quarter marks come in that investors have an understanding of whether [core assets] are at a valuation that would be interesting before they start to invest in it again," he said.
PREA's survey illustrates an appetite for multifamily, industrial, data center and medical office investments among institutional investors. But in practice, there will likely be no shortage of strategies to come out of the pandemic, even among CRE's biggest investors, Solomon said.
“I think there are as many perspectives among institutional investors on how to react to essentially a repricing of the market, as there are institutional investors," he said.
