Investors have slowed capital deployment into real estate due to being over-allocated to the asset class, but continue to set aside capital to target opportunities that may arise, according to a report.

The report by Hodes Weill & Associates and Cornell University found that institutions continue to increase target allocations to real estate, with the expectation that “attractive buying opportunities” will emerge over the next several years.

This comes despite the fact that “economic turmoil, geopolitical risk, and rising inflation and interest rates” have contributed to the first decline in institutional investor confidence in real estate in five years, according to the 10th annual Institutional Real Estate Allocations Monitor survey.

Average target allocations to real estate rose to 10.8% in 2022, up 10bps from 2021, which is consistent with the rate of increase recorded over the past four years. Average target allocations have increased by approximately 190bps since the survey began in 2013.

Strong portfolio returns combined with the denominator effect are contributing to overallocation in institutional portfolios, according to the 2022 Allocations Monitor.

Advisory firm Hodes Weill and Cornell University’s Baker Program in Real Estate surveyed 173 institutions, owning some $1.1trn (€1.06trn) real estate assets, for the report.

The percentage of institutions reporting overallocation has more than tripled year over year, with 32% of institutions invested above their target allocations, compared to 8.7% in 2021.

Concerns of overallocation, along with declining conviction, led to a significant slowdown in deployment pacing, beginning in the second quarter of 2022, the report said.

Decreased conviction coupled with portfolio overallocation has resulted in a slowdown of deployment pacing. But while today’s investment environment is challenging, institutions are expecting to increase allocations to real estate by 30bps to 11.1% in 2023, the report said.

Real estate has continued to outperform target expectations in institutional portfolios. On a trailing five-year basis, institutions have seen an average annual return of 9.9%, significantly ahead of the average target return benchmark of 8.2%.

Following underperformance in 2020, institutional real estate portfolios bounced back in 2021, generating an outsized average annual return of 17.1%.

This outperformance, combined with the denominator effect, has contributed to a tripling in the number of institutions reporting overallocation to real estate.

Approximately 32% of institutions report being invested above their target allocations. The result has been a significant slowdown in deployment pacing, which began in the second quarter of 2022. The expectation is that institutions will remain largely on the sidelines until portfolios come back into balance, through some combination of a reversal of the denominator effect and anticipated write-downs in the value of private real estate holdings, the report said.

Douglas Weill, a managing partner at Hodes Weill & Associates, said: “While institutions have slowed their pace of deployment in the face of overallocation, it is likely they’ll be highly active in the next two years as compelling investment opportunities emerge following this period of uncertainty. If market volatility leads to distress and dislocation, the next several years may prove to be good vintage years for capital deployment.

“There are already signs of institutional capital returning to the market to take advantage of distress, with several pensions and sovereign wealth funds actively investing in public REITs and debt securities, and deploying capital into credit strategies.”

The report said the US remains the preferred destination for international capital allocations; however, the survey notes that cross-border capital flows have decelerated over the past year as foreign exchange-rate risk, geopolitical tensions and a weakening global economy are making foreign investments a riskier bet.

Institutions universally expressed declining interest in the UK, with 53% of investors reporting actively allocating to the region, down from 61% in 2021, the report said.

To read the latest edition of the latest IPE Real Assets magazine click here.