KPMG and RE-Invest surveyed select investors and asked their assessment of the global real estate markets and their investment strategies for 2015. Respondents are drawn from a range of organisations which together control real estate assets valued in excess of €580bn.
The global real estate market continued to surge ahead in 2014, driven by increasing economic stability and improvements in access to capital as investors increased their geographic reach. Access to investment opportunities is a major concern and is considered the greatest threat to growth by 48% of respondents.
Whether it be geographical expansion, expanding investment strategies, new asset classes or new asset sectors, investors are widening their reach and building increasingly diverse investment portfolios. 64% of respondents employ a global strategy, compared with 39% in 2014.
Core remains king as 75% of respondents employ a core investment strategy; however, there is a trend towards opportunistic, value-added strategies to drive returns and improve access to opportunities. Offices continue to dominate sector preferences with over 30% of respondents looking to gain further exposure, despite yields tightening across many markets.
Real Estate is now largely embedded in many portfolios and not considered as ‘alternative’ as it once was. High profile increases in recent years have often involved investors expanding into real estate investment.
Recent converts to real estate investment are busy building their platforms and gaining experience, and therefore may not be in a position to challenge themselves with increased targets. Competitive markets also mean it can be hard to deploy capital quickly and thus existing targets may remain illusive to even experienced teams. Capital needs to be generating a return; it can’t be idle.
As competition has grown to new heights we are noting increasing partnering and club deals through our day-to-day client activities and this is clear from the results as 84% of respondents employ these structures compared with 76% investing direct or via separate account mandates; a reversal of 2014’s results where direct/separate account mandates were employed by 81% versus 55% investing via club or joint venture structures.
Experience in the industry
There is much talk of a shift to alternatives and clear signs that many major institutions are considering risk and portfolio diversification more actively in this ‘new age’. With over half of the respondents organisations having over 20 years experience of investing in real estate it is clear that this asset class is not considered new to many. It is also somewhat comforting to note that this experience should bring with it some stability to the volume of capital flowing into real estate. While these new entrants may be new to the region they may not be new to the game.
Allocations to real estate
Respondents are drawn from right across the global marketplace; however, respondents derived from organisations running multi-asset strategies are responsible for managing an average of 10% of invested allocation and are seeking an average target allocation of 13%.
While 78% of respondents are not expecting to alter their allocations, generally those with allocations at the lower end of the spectrum do expect to increase these over the next 12 months: 17% of respondents expect to increase their invested allocation by 1% on average; 13% expect to increase their target allocation by an average of 2%. While 4% expect to reduce their allocation this is restricted to above average allocation rates and does not signal an exit from the sector.
There is a marked step-change when we compare these results with those seen in 2014 when 81% expected to increase their allocations and we feel there are a number of factors at play here. Firstly is the familiarity with real estate. For many organisations real estate is no longer fundamentally ‘alternative’; it has become ‘normal’ and the asset class is understood and accepted. For other more recent additions to the market there is a steep learning curve during which they are unlikely to take significant additional bets on the market until you are familiarised and the supporting structures and processes fully tested. Finally a critical factor is the ability to put this capital to work. As is discussed later in this document the challenge of sourcing investment opportunities is ever present.
A clear preference for investment structures that provide higher levels of control over either the asset or the strategy dominates figure 3. Nearly all of the routes to investment have seen growth, driven by the need to diversify in a highly competitive market. Only debt had seen a significant drop off which is surprising given the columns dedicated to debt funds seen in the industry’s media. However, it is a fundamentally different product which requires additional specialist skills and resources. While direct/separate account mandates have seen a small decline, this is set against a significant increase in joint venturing and club deals. In our view there are two key drivers for this: one, competition and avoiding a race to the top price; two, the desire to tap into local knowledge and expertise through partnering.
When posed the question, ‘What is your primary investment strategy?’, it was interesting to note that many of our respondents were really split. Given the options of core/income focus and opportunistic/capital growth, 28% of our respondents were unable to come down on one side of the fence. As a result 75% of respondents employ a core strategy while 54% take an opportunistic approach. Again, we feel this demonstrates the difficulty our clients and other industry participants are finding in sourcing and securing investment opportunities. As a result many are having to consider alternative risk profiles when revisiting or diversifying their investment strategies whether it be geography or asset type.
However, while there is much talk of moving up the risk curve, the proportion of respondents employing a core strategy has actually increased from 61% in 2014 (67% in 2013), so it would seem that an asset-led, more flexible approach is being adopted in the face of low supply.
Respondents were asked to share with us what the key principles that underpin their strategy are. While no one would be surprised to see stable income take the top spot the themes that run through these responses demonstrate further the appetite for more opportunistic activities.
The focus on partnering and skills is also worth a mention. While the respondents employ a variety of structures (in-house versus outsourced), skills and demonstrable track records have been under increased scrutiny since the global financial crisis. Active asset management, tapping into local knowledge and alignment of interests are all key.
While 64% of respondents employ a global strategy to real estate investment, of those adopting a regional strategy most are investing in EMEA (36%) with 12% having exposure to Asia-Pacific and 4% having exposure to the Americas. None of our respondents are currently investing in a pure domestic manner in contrast with the 2014 results where 16% of respondents were pursuing a domestic strategy. While the proportion of regional investors has declined slightly from 45% in 2014, the shift to a global strategy is marked – increasing from 39% in 2014.
Western Europe, the UK and US remain the most popular while Southern Europe has lost some ground, having had 35% of respondents in 2014 pick it as a market showing the best opportunity.
This year we have split out the UK from western Europe, due to the high volumes of capital that flows to this market and while these two markets dominate in figure 7, the combined interest in increasing exposure to the UK and western Europe (44%) has not managed to exceed the massive 81% interest it received in 2014. These markets have enjoyed significant investor appetite for some time now and there are a number of factors combining, including lack of supply, renewed euro-zone concerns and currency risk, that could explain this slow down in appetite.
Set against this though, is the volume of respondents looking to reduce their exposure to these markets. We believe this is because organisations are seeking to realise the gains available, given the volume of inbound cross-border capital-seeking opportunities in the region. Other investors may also find themselves being forced to reduce their allocation to these high performing markets given the high competition for assets if they are unable to meeting or justify the pricing levels. We don’t believe that the ‘decreases’ signal any major shifts in attraction to real estate but rather a housekeeping exercise to realise and protect value.
Turning to the Americas, North America received 32% of the vote for the market with the best opportunities in 2014 and exactly the same volume of respondents are expecting to increase their allocation to the US over the next 12 months. None of the respondents signalled an increased interest in Canadian real estate. Latin America is of interest to 16% of our respondents, versus 10% signalling that it was a region offering the best opportunities in 2014. This interest is not restricted to North American investors but encompasses participants with appetite from each of the three key regions.
Asset sector exposure
While all sectors appear to have secured the interest shown in 2014, what is worth noting is the diversification of investments held by these institutional investors. While the on-trend alternative classes such as student housing, healthcare and data centres are all represented, perhaps more surprising is the significant interest in less traditional investment sectors such as suburban offices and high street retail, as one respondent highlighted, it can be difficult to find institutional funds for high street retail.
While the trend towards increased exposure across the sectors is understandable, driven by the competitive environment and the desire for diversification, the results show further increases in appetite for asset classes such as offices and shopping centres where the core end of the market is seeing yields tightening.
How long do they hold their investments?
Given the desire for long-term stable income by many institutional investors, it would be natural to assume that hold periods would be far longer than the traditional fund model. However, the results indicate that this would be an unfair assumption.
Having touched on the potential for portfolio churn and realising gains above, the results for the target hold period show that the bulk of respondents hold their investments for less than 10 years. The results show little correlation between investor type or domestic location. We feel that many institutional investors are evolving to become more agile in their approach. While there are traditional examples still available it is clear that no one size fits all.
Target IRRs, unsurprisingly, are towards the lower end of the spectrum given the appetite for core assets in a highly competitive market. While there is strong correlation between investors that employ core strategies versus those that opt for opportunistic, only 8% of respondents anticipate a change in IRR in the forthcoming year. Essentially, it is ‘business as usual’ for the real estate industry regardless of competition and yield compression widely muted in the market forecasts.
What is keeping investors awake?
Unsurprisingly, supply and economic growth are the fundamental concerns for our participants. So many of the trends demonstrated are driven by competition and a race to secure investment opportunities but clearly for real estate to generate a total return and add value to an investor the economic fundamentals are vital. With a recent slowdown in GDP growth across a number of the key real estate markets it is only natural that this would be of concern to our respondents