Fund managers are over-estimating demand for core product as investor -preferences move up the risk curve. This mismatch is among the findings of the latest -INREV Investment Intentions Survey, presented here by Shetal Patel

Investors and fund managers are adapting to radically different market circumstances and although the effects of the downturn are still very much with us, there are now signs of some recovering markets, which give investors cause for optimism.

The findings of the recently completed INREV Investment Intentions Survey 2011 highlight a clear shift toward more investor involvement. The preferred styles, strategies and real estate types that investors are expecting to invest in during the next year show that knowledge about funds and security are highly sought after. With the possible impact of upcoming regulations and the increased preference for alternative products such as debt there is a reflection of an evolving market.

Non-listed real estate funds will likely benefit from an increase in allocations from investors according to the survey, with 55% of respondents expecting to increase their non-listed allocations compared with 49% from last year's survey. Although non-listed real estate funds fare well in the survey, the same cannot be said for listed property funds, which can expect a decrease in allocations from investors. However, there have already been major signs of recovery in the listed market, with the non-listed sector lagging behind.

The greatest expected increase in allocations is to joint ventures, with 67% of investors expecting to increase their allocations to them. This reflects a substantial rise from the 40% of investors that expected to increase their allocations to joint ventures in last year's survey. Typically, joint ventures allow investors to have more discretion over their investments and an increase in expected allocations to them might be a reflection of investors' desire for more control.

Although investors are taking a more conservative approach, fund managers perceive them to be more cautious then they actually are. The survey found that among the three fund styles, core remains the most popular with investors, fund of funds managers and fund managers. However, there is an apparent mismatch between investors and fund managers. Fund managers overestimate the demand for core funds from investors by 19%, which is mostly at the expense of value-added funds. A possible explanation is that investors change their preferences more quickly than fund managers can follow. Investors are showing an interest in more risky products but adopt a more conservative approach for each of the different styles. Fund managers have responded later to investor demand, especially over the past 18 months when the length of time taken to market and to close a fund has increased.

Investors are also showing a preference for single-country and single-sector funds, again highlighting a mismatch between fund managers and investors, as close to 90% of investors prefer single-country funds but only 60% of fund managers perceive this to be the case. Multi-country, multi-sector strategies are usually associated with less risk due to the diversification benefits they offer; however it might be argued that a single-country, single-sector strategy actually might have less risk because there is a better understanding of that particular market. Investors, particularly the larger ones, prefer to diversify at a portfolio level rather than at a fund level and by doing so have more control over the way that they diversify.

For 2011, German retail is the preferred market-sector combination among investors and German office is the third, showing that the improvement in the German economy is likely to have instilled a level of confidence in investors. The second most favoured market-sector combination is French office, although the Nordic countries have also increased in favour among investors compared with previous years. In the past the UK has featured more strongly in the top ten than it did this year. However during the past 18 months there has been a steep recovery in property prices in the UK, making it less attractive than other European markets. Germany is also more favoured by German investors, which highlights a home bias among them, while investors from other countries focus more on non-domestic markets when investing in non-listed real estate funds.

The survey also shows over 80% of investors and fund managers indicating a preference for seeded funds over blind pooled funds, reflecting a major turnaround from last year's study. With the increased demand for control and knowledge about funds that is seen in the market today, the security of knowing the assets before investing in a fund is appealing to many investors. Seeded funds also let investors know whether fund managers follow the strategy that they are targeting, providing an extra layer of reassurance. Another possible explanation could be that the preference for seeded funds reflects confidence in the direction the market is moving in, as it suggests that investors do not expect a substantial drop in the value of assets.

The increased demand for investor control is also reflected in other areas of the survey, with the majority of investors preferring to be actively involved in their funds and to invest alongside a small pool of investors that are similar in terms of organisation and structure. These preferences highlight the security that is being sought and also suggest that alignment between investors as well as with fund managers is much more important today.

The survey also points to a growing interest in alternative products such as real estate debt funds, mezzanine debt and real estate derivatives. Some 36% of investors have already made an investment in mezzanine debt and 27% in real estate debt funds, suggesting that debt funds are likely to play an important role for investors in the future.

Regulation has previously been perceived as an obstacle for fund managers in non-listed real estate funds, and since the crisis this is a topic that is at the forefront of both investors' and fund managers' minds. The introduction of the new EU regulations designed to avoid a future crisis will surely affect the way that the sector moves forward, and the survey explored the extent to which they are having an impact on investors' intentions today. The survey showed that the majority of respondents are aware of Basel III, Solvency II and the AIFM Directive, but only 16% of investors and 9% of fund managers are holding back from making new investments because of these regulations. This could be because the industry is not fully aware of the impact of the regulations as the details are not yet finalised and they are still not in force.

The cautious risk-averse investor that is seeking more control and knowledge characterises the market today and investors are likely to move toward product types and strategies that provide extra reassurance. Regulations will also have an impact on the way that the industry moves forward, but the extent of their impact is not yet known. But investors are optimistic about non-listed real estate, showing that it is still an important investment strategy.

Shetal Patel, INREV Research & Database Manager