The sixth annual Institutional Real Estate Allocations Monitor from Hodes Weill & Associates and Cornell University finds that global appetite for investment in commercial real estate remains strong, particularly among institutions in the Asia-Pacific, Europe, the Middle East and Africa regions.
The report says that after exceeding the 10 per cent threshold for the first time ever in 2017, the average target allocation to real estate increased 30 basis points among global institutional investors to reach 10.4 per cent in 2018. Moreover, institutions are forecasting a further increase of 20 basis points over the next 12 months, the report says.
Douglas Weill, Managing Partner at Hodes Weill & Associates, says: “Real estate as an asset class continues to grow as more institutions seek to diversify their portfolios through greater exposure to alternatives. Interestingly, while the US is still the preferred destination for investment, institutions are increasingly favouring investments in Europe and Asia as attractive opportunities in the US become harder to find. We expect allocations to real estate will continue to rise steadily given the growing number of institutions that are expressing confidence in the asset class’ many benefits.”
This year’s 30-basis-point increase in target allocations aligns with a slight uptick in investor sentiment noted in the survey’s ‘Conviction Index’, which measures institutional investors’ views of real estate as an investment opportunity from a risk-return standpoint. Following four years of steady decline, the Conviction Index increased from 4.9 to 5.1, representing the first year-over-year increase since the survey launched in 2013.
The report shows that growth in investor sentiment was consistent across all regions including the Americas, APAC, and EMEA. Sentiment among APAC-based institutions increased by the widest margin at 0.5 points following a meaningful decline between 2016 and 2017. This confidence can likely be attributed to APAC institutions achieving the highest average annual returns over the past three years at 10.0 per cent. Despite concerns about late-cycle valuations for real estate, a sovereign wealth fund that participated in the survey commented: “Compared to other asset classes, real estate still appears more attractive and we must continue to invest.”
Dustin Baker, Director of the Baker Program in Real Estate at Cornell University, says: “Institutional real estate portfolios delivered solid investment returns in 2017. Returns continue to outperform expectations, which is likely contributing to the increase we are seeing in investor conviction. This has in turn led to an acceleration in transaction volumes and capital deployment across regions.”
Among the range of institutions surveyed, insurance companies and public pensions increased their target allocations by 50 and 30 basis points, respectively. This is largely due to insurance companies seeking greater exposure to yield-producing real estate to match liabilities. The growth in public pensions was primarily driven by European pension plans, which increased target allocations by 70 basis points year-over-year. With a 130-basis-point decrease, endowments and foundations had the most significant year-over-year reduction in target allocation.
Looking forward, global target allocations to real estate are expected to increase 20 basis points over the next 12 months, which is at the low end of the historical 20 to 40 basis point average. This can be attributed to institutions in the APAC and EMEA regions, each of which is forecasting an average increase of 40 basis points. Conversely, target allocations of institutions in the Americas are expected to remain flat owing to concerns regarding rising interest rates, asset valuations, and geopolitical risks, in addition to the perception of being late in the cycle.
While global real estate allocations continue to climb, albeit at a slower rate, the report found that institutions remain approximately 90 basis points under-invested relative to target allocations. Of the whole, approximately 60 per cent of institutions are under-invested by an average of 200 basis points. When segmenting by type of institution, insurance companies are, on average, the most under-invested at 7.3 per cent, while endowments and foundations are tracking close to their target allocations.
From a regional standpoint, APAC-based institutions were the most under-invested group for the second straight year at a margin of 120 basis points below target allocation, according to the report. This may be attributed, in part, to cross-border investment controls placed on Chinese institutions, which substantially reduced capital allocations from some of the largest and most active global institutions, they say.
Institutions continue to favour closed-end funds with approximately 93 per cent actively allocating capital to these vehicles, up from 87 per cent in 2017.
Moreover, higher-returning valued-add strategies remain the strong preference among 90 per cent of institutions surveyed. Approximately 63 per cent of institutions are focusing on core strategies, down 6 per cent year-over-year, owing in large part to concerns regarding frothy valuations. Institutions are outsourcing approximately 85 per cent of their new investment allocations to third-party managers, driving strong growth in assets under management for the investment and fund management industry.
Worldwide, institutional real estate portfolios generated an average annual return of 9.2 per cent in 2017, up from 8.7 per cent in 2016. The year-over-year increase in returns may be attributed to the acceleration of economic growth that occurred in late 2016 and continued into 2017, and which led to strong operating fundamentals for the sector. The report confirmed that institutions continue to achieve returns well above their long-term targets, with the 5-year average return for all institutions outpacing target returns by 210 basis points.
As it relates to Environmental, Social & Governance considerations, the report found that 39 per cent of institutions indicate that they have a formal ESG policy, up from 36 per cent in 2017. Only a quarter of institutions in the Americas reported that they are influenced by ESG policies, indicating that they are considerably less focused on environmental and social considerations, relative to institutions in EMEA and APAC.
The 208 institutions that participated in this year’s survey represent aggregate AUM of USD11 trillion and portfolio investments in real estate totalling approximately USD1 trillion.
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