Cornell University and Hodes Weill have started an annual survey of global institutional investors in real estate. Doug Weill reveals some of the results.
European institutions are significantly under-invested in real estate, which is resulting in greater capital flows into the sector. This is one of a number of findings from the 2013 Institutional Real Estate Allocations Monitor, which was conducted by Cornell University’s Baker Program in Real Estate and Hodes Weill & Associates.
Institutional allocations in Europe are expected to increase, indicating that the pace of annual investments is likely to continue to accelerate well beyond 2014. Cross-border capital flows to Europe are expected to rise as the UK and continental Europe have returned as desired destinations for both domestic and international capital, as real estate fundamentals recover from the depths of the global financial crisis.
After several years of volatile performance and an industry-wide slowdown in real estate investment activity, European institutions have returned to the asset class in force. Following the global financial crisis, many institutions suspended new investment activity. For many, this was due to over-investment relative to target allocations. This was caused, in part, by the ‘denominator effect’ (falls in the value of other liquid asset classes causes the real estate weighting to increase), and lack of realisations and distributions. However, a significant majority of institutions maintained target allocations to real estate. This was in contrast to the late 1980s and early 1990s when many institutions liquidated their real estate holdings following several years of disastrous investment performance. This suggests that real estate has a permanent home in institutions’ portfolios and may be poised to grow significantly over the coming decade.
Results of the survey indicate that UK and European institutions currently have 10.8% of their portfolios invested in real estate (figure 1). This compares with an average target real estate allocation of 11.9%, indicating that institutions are, on average, 114bps under-invested. We attribute the gap in portfolio investments to a combination of factors, including increases
to previous target allocations, a slowdown in investment activity over the past several years, new entrants into the asset class and the strong performance of other asset classes, including public equities, fixed income, and alternatives (a reversal of the previous denominator effect).
Globally, institutions are under-invested in real estate by an average of 97bps versus their target allocation. Applying the 97bps of under- investment to the $7.2trn (€5.3trn) of assets under management reported by survey participants (or more broadly to industry estimates of $60-80trn of global institutional assets under management), would imply substantial ‘dry powder’ for new real estate investments over the coming years. While we recognise that these percentages are subject to substantial fluctuations, these figures are indicative of continued momentum in the pace of institutional investments over the next several years.
In 2014, European institutions’ target allocations to real estate are expected to rise by an average of 56bps to 12.5% (figure 1). In 2014, some 48% of institutions expect to increase their target allocations – on average, by 115bps. More than half (52%) of institutions are expected to keep their targets, while none are expected to reduce their targets in 2014. These figures indicate that the pace of investment in Europe should increase over the coming years.
Approximately 83% of European institutions were actively investing in real estate in 2013, up from 66% in 2012 (figure 2). Over 70% of institutions planned to invest the same or a greater amount of capital in 2013, compared with 2012, while just 11% of institutions planned to decrease their investment activity in 2013.
Notably, overall investment activity in private real estate funds has increased substantially since 2012. Around 60% of institutions indicated they were actively pursuing investments in private funds in 2013, compared with 30% in 2012. Approximately 43% of institutions planned to increase the amount of capital invested in private funds in 2013, while only 9% expected to reduce their pace of investment in private funds.
Across the globe, institutions have been actively allocating capital to cross-border strategies. While institutions worldwide were most interested in making investments domestically, their appetite for international investment is rising. In Europe, institutions are most focused on investments in continental Europe, but continue to look abroad for higher return strategies (figure 3). For European investors in 2013, strategies targeting North America were equally as important as strategies targeting the UK. Institutions in Asia Pacific and the Americas remain significantly under-invested to real estate and expect to increase their target allocations to the asset class (figure 1). They are increasingly interested in pursuing opportunities focused on European real estate (figure 3). The UK and continental Europe have returned as a desired strategy, demonstrating that the fear of continued falling market and break-up of the euro-zone have receded. These figures indicate a potentially substantial increase in the amount of cross-border capital from the Americas and Asia Pacific into Europe.
Institutions in the Americas are the most likely to use third-party managers, while those in Europe are most likely to manage assets internally. All institutions, regardless of size or location, are more likely to outsource invest- ments than manage internally.
Some 84% of European institutions outsource at least a portion of their investments to third- party managers. Over 40% have all of their real estate managed by third parties and approximately 56% have more than half of their real estate managed by third parties. Nearly 40% of institutions manage a portion of their real estate portfolio in-house.
Over 70% of European institutions allocating capital to new real estate investments in 2013 were focused on re-investing with existing managers. However, some 50% were willing to invest with new third-party manager relationships.
In conclusion, after several years of contraction following the global financial crisis, institutional investment in real estate is expected to grow over the next decade. European institutions are significantly under-invested in the asset class and are raising their target allocations. Capital into European real estate from institutions abroad should continue to accelerate as more opportunities arise. The asset class is becoming more global and institutions are shifting portfolio investments to third-party managers. Despite the purported demise of private real estate funds, commitments are rebounding as institutions return to international programmes and higher-return strategies.
Doug Weill is co-founder and managing partner of Hodes Weill & Associates