Institutions Slow Capital Deployment into Real Estate Due to Overallocation, but Continue to Increase Target Allocations in Anticipation of Attractive Buying Opportunities Over the Next 12 to 24 Months, Finds Hodes Weill & Associates and Cornell University
Average target allocations increased 10 basis points in 2022 to a ten-year high of 10.8%, which is expected to support liquidity and transaction volumes over the coming years
However, in the short-term, a combination of overallocation and decreased conviction is slowing down the pace of capital deployment
After under-performing in 2020, institutional real estate portfolios generated an outsized average return of 17.1% in 2021, as operating fundamentals remained strong and valuations surged
Strong portfolio returns combined with the denominator effect are contributing to overallocation in institutional portfolios
Global economic uncertainty, geopolitical risk and an inflationary environment contributed to a decline in investor sentiment year-over-year
Target allocations to real estate expected to increase by a further 30 basis points in 2023, as investors anticipate an opportunity to take advantage of potential repricing and dislocation
NEW YORK (November 15, 2022) – Institutions continue to increase target allocations to real estate, with the expectation that attractive buying opportunities will emerge over the next several years – finds the 10th annual Institutional Real Estate Allocations Monitor, published by Hodes Weill & Associates and Cornell University’s Baker Program in Real Estate. 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. 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 30 basis points to 11.1% in 2023.
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The decline in investor confidence noted in the survey’s “Conviction Index” – which measures institutions’ view of real estate as an investment opportunity from a risk-return standpoint – reflects a cautious view of the market, which has contributed to the slowdown in capital flows and transaction volumes seen over the course of this year. The index declined from a ten-year high of 6.5 in 2021 to 6.0 in 2022.
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.
Target allocations to real estate increased for the ninth straight year to 10.8% in 2022 – up 10 basis points from 2021 and consistent with the annual rate of growth over the last four years. This increase in target allocations implies the potential for an additional $80 to $120 billion of capital allocations to real estate in the coming years. Institutions are forecasting a further increase of 30 basis points in 2023, which would be the largest year-over-year increase since 2014. Anticipated growth in allocations is fairly consistent across regions, with institutions in the Americas expecting to increase allocations by 40 basis points, and institutions in the EMEA and APAC regions expecting to increase allocations by 30 basis points and 20 basis points, respectively.
Douglas Weill, 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 United States remains the preferred destination for international capital allocations, however, the survey notes that cross-border capital flows have decelerated over the last 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 U.K., with 53% of investors reporting actively allocating to the region, down from 61% in 2021.
Despite a decline in investment appetite across the risk spectrum, higher-return strategies remain in favor, with 84% of institutions actively allocating to value-add and/or opportunistic strategies in anticipation of pricing dislocation. The current interest rate environment has created challenging market conditions, leading to a decline in appetite for core strategies across all regions and contributing to growing net redemptions in open-end funds. Though the first three quarters of 2022 marked the slowest period of fundraising since 2013, closed-end private funds remained popular with institutions in 2022, with 74% of investors actively allocating to such funds.
While a select number of larger institutions report that they are working to internalize portfolio management, most institutions continue to rely on the expertise of third-party managers, expecting to allocate approximately 90% of future investments to external managers. The report notes that institutions maintain a high bar for investing with new managers, which has only increased with today’s market uncertainty. Among the most important considerations for investment with first-time fund managers today is the team’s experience investing during market downturns. Managers with cycle-tested teams are better positioned to receive capital allocations in today’s environment.
ESG continues to be a growing focus of investors globally, with 56% of institutions now reporting that they have implemented a formal ESG policy, up from 50% in 2021 and 32% in 2016. All Australia-based institutions report having ESG policies in place that influence investment decisions, followed by Europeans at 81% and Canadians at 80%. At 25%, the United States continues to lag behind its peers in adopting ESG policies. A heated movement of anti-ESG rhetoric has made its way into U.S. politics in 2022, influencing in part how and where public pensions allocate capital. It remains to be seen whether this rhetoric will impact institutions’ ESG policies over the medium and long-term, with many indicating that abandoning ESG efforts – particularly as it relates to climate change – would pose significantly more risk to portfolio performance over the long-term.
173 institutions from 34 countries participated in this year’s survey, representing aggregate AUM of US$11.1 trillion and portfolio investments in real estate totaling approximately US$1.1 trillion.
About Hodes Weill
Hodes Weill & Associates is a leading, global capital advisory firm focused on real estate, infrastructure and other real assets. The firm has offices in New York, Denver, Hong Kong, London and Amsterdam. Founded in 2009, Hodes Weill provides institutional capital raising for funds, transactions, co-investments and separate accounts; M&A, strategic and restructuring advisory services; and fairness and valuation analyses. Clients include investment and fund managers, institutional investors, lenders, and public and private owners of assets and portfolio companies. For more information, please contact or visit www.hodesweill.com
*All U.S. regulated capital market and securities advisory services are provided by Hodes Weill Securities, LLC, a registered broker-dealer with the SEC, and a member of FINRA and SIPC, and internationally, by non-U.S. Hodes Weill affiliates.
About Cornell University’s Baker Program in Real Estate
Cornell’s Baker Program in Real Estate is home to the Masters of Professional Studies in Real Estate degree, a comprehensive, graduate-level curriculum that educates the next generation of real estate industry leaders. Cornell is also home to the Cornell Real Estate Council (CREC), a global network of over 3,000 real estate industry professionals and students, and host of the annual Cornell Real Estate Conference. For more information, please visit https://baker.realestate.cornell.edu/
For informational purposes only. This is not a solicitation to buy or sell any securities or securities products. Please refer to the full report for important disclaimers. The full report can be found at www.hodesweill.com/research