GLOBAL - Partners Group has cast doubts over the continuing flight to quality in core real estate markets and made the case for investing in secondary assets and locations.

In its latest market report, the private markets specialist said: "We highly doubt that many of the recent flows into core will turn out to be promising investments."

Claude Angéloz, co-head of real estate, told IP Real Estate that core was being targeted by investors on the assumption that it represented the "lowest end of the risk/return spectrum".

However, he said, in an environment where yields are extremely low, "core does not provide this security in all market scenarios", especially one of rising inflation, where property valuations can be negatively affected if cap rates move in parallel.

Partners Groups 'Private Markets Navigator' report, released today, warned that once interest rates rise, "investors may start to deem yields and yield spreads of trophy properties less attractive and move up the risk/return spectrum searching for additional yields".

It added: "Now is the time to invest outside of the core space where assets are still attractively valued."

Angéloz told IP Real Estate that higher-yielding "B-class assets in first-tier cities" or "grade-A assets in second or third-tier cities" could provide a "much needed cushion" should inflation put pressure on property yields.

He said assets that allowed for "valuation increases through active management", such as those with 20-30% vacancy rates or (re-)development potential, could provide an additional hedge.

"All these measures provide you with additional flexibility and more control so you can create more value in an environment where valuations might go against you," he said.

Partners Group, which has been an active investor in the mezzanine finance space, is similarly sceptical of the junior debt opportunities in the prime end of the market.

It said: "Partners Group no longer considers junior real estate debt opportunities attractive in tier 1 markets such as London City or Munich, where mezzanine lenders earn no more than a margin of 300-600 basis points over Libor, while taking on substantial cap rate expansion risk.

"The markets we consider most attractive are tier two and tier three cities in large real estate markets, which still fail to attract global capital flows even where fundamentals are solid."

For more analysis and a full interview with Claude Angéloz, see the next edition of IP Real Estate in September.