Real estate allocations and confidence rise despite COVID-19 disruption

Real estate allocations and institutional investor confidence in the asset class have both risen this year, despite the uncertainty and disruption wrought by COVID-19, according to a report.

The eighth annual Institutional Real Estate Allocations Monitor survey by Hodes Weill & Associates and Cornell University found that investor sentiment rose for the third straight year in 2020.

Its “conviction index”, which measures institutional investors’ view of real estate from risk-return perspective, increased from 5.7 to 5.9.

The confidence comes off the back of strong performance: although the average real estate return among investors declined by 30bps in 2019, it remained above average target return of 8.3%.

Advisory firm Hodes Weill and Cornell University’s Baker Program in Real Estate surveyed 212 investors, owning some US$1.3trn (€1.06trn) real estate assets, for the report.

In recent years, the survey found that investors were meaningfully below their target allocations to real estate, but this year’s results suggest the gap is closing.

Target allocations rose 10bps in 2020 to 10.6%, while actual allocations climbed from 9.4% to 10%, in part due to the denominator effect of falling values in other asset classes, the report said.

Investors cited a number of reasons for increasing target allocations: low correlation of investment returns to other asset classes; favourable supply-and-demand fundamentals; and the opportunity to generate attractive income yields.

Douglas Weill, managing partner at Hodes Weill & Associates, said: “While the impact of COVID-19 and geopolitical issues on commercial real estate remains a concern, institutions anticipate that a potential buying opportunity is emerging as distress and dislocation become more prevalent.

“We expect that this, combined with rising sentiment in favour of the asset class, will lead to an increase in investment pacing. Moreover, liquidity is expected to increase, which should continue to support asset pricing, transaction volumes and cost of capital.

“All things considered, real estate continues to provide attractive returns relative to other asset classes in a market defined by prolonged uncertainty.”

According to the report, value-add strategies remained the strongest preference for institutions globally, although many are shifting their focus to higher-return strategies to capitalise on anticipated dislocation resulting from the pandemic.

Asia-Pacific investors have led this trend, with 73% of investors from the region focused on opportunistic investments – up from 40% in 2019.

About three quarters of Americas-based institutions and 62% of EMEA-based investors are actively allocating to opportunistic strategies – compared to 65% and 51%, respectively, in 2019.

The survey also picked up on a shift to domestic investments – although cross-border capital flows remain strong, it said, the percentage of institutions investing outside of their domestic region decreased for the third straight year.

The trend is being led by Asia-Pacific investors whose willingness to allocate to strategies outside of their domestic region decreased by 10%.

North America continues to be the largest recipient of global capital allocations due to the liquidity and relative stability the region affords, followed by continental Europe, the report said.

One Americas-based insurance company stated for the report: “The market is bifurcated between the ‘haves’ and ’have nots’. Industrial, data centres, and life-science sectors are experiencing strong demand from debt and equity, and will likely benefit from cap rate compression. Hotel, retail, and office will continue to face liquidity challenges until we get through COVID and the economy recovers.”

Closed-ended funds remained in favour with global institutions, with 82% actively allocating capital to funds. However, allocations to closed-end funds remain 11% below their peak in 2018. Open-ended private funds saw a 4% uptick in allocations, with 55% of institutions targeting them.

While larger institutions continue to shift allocations to direct investments, separate accounts and joint ventures, 91% of institutions report interest in allocating to private funds – in particular for opportunistic and specialised strategies.

The report found that investors are outsourcing approximately 85% of their new investment allocations to third-party managers, which it said was driving continued double-digit percentage growth in assets under management for the investment management industry.

Investors continue to favour allocating capital to existing manager relationships, with 62% of 2020 investments earmarked for groups with which institutions have pre-existing relationships.

Conversely, willingness to invest with emerging managers remains low at 12% among all respondents, reflecting a strong preference for established managers during times of uncertainty, the report said.