The real estate asset class continues to experience growth in institutional capital allocations. In fact, 2017 represents an important milestone in this regard according to Hodes Weill & Associates and Cornell University’s fifth annual Institutional Real Estate Allocations Monitor. This year’s survey revealed that for the first time, global institutional investors’ average target allocation to real estate surpassed the 10% threshold.
“Real estate has proven over time to be an important portfolio diversifier, producer of stable income and hedge against inflation, which is why it’s no surprise that this strategic asset class now exceeds a target allocation of 10% in global institutional portfolios.”
The Allocations Monitor shows that the average target real estate allocation increased to 10.1% in 2017, up from 9.9% in 2016 and 8.9% in 2013—the year in which the survey was first conducted. Over the past five years, institutional portfolios have increased their exposure to real estate from 8.5% to 9.1% invested. This implies that real estate portfolios have increased by approximately $0.5 trillion in total value, through a combination of capital appreciation and new investments.
Douglas Weill, Managing Partner at Hodes Weill & Associates, said, “Real estate has proven over time to be an important portfolio diversifier, producer of stable income and hedge against inflation, which is why it’s no surprise that this strategic asset class now exceeds a target allocation of 10% in global institutional portfolios.”
Although real estate has enjoyed a steady uptick in target allocations, the report reveals the pace of target allocations is moderating. Approximately 22% of institutional investors surveyed indicated that they expect to increase their target allocations over the next 12 months, down from 30% in 2016. What’s more, the pace of increase in target allocations slowed to 20 basis points in 2017 compared to an average of 30 to 40 basis points per year since 2013.
“While exceeding the 10% threshold is a seminal moment, the steady growth in allocations to real estate that the industry has experienced over the years appears poised to decelerate in the near term. This is due primarily to waning investor confidence, a trend that we’ve seen grow increasingly stronger since we first began conducting the survey. However, we anticipate that the long term outlook for institutional capital allocations to real estate will remain positive given the asset class’ many benefits,” continued Weill.
The report notes that a bevy of factors have contributed to a significant year-over-year decline in institutional confidence in the asset class. The survey’s “Conviction Index,” which measures institutional investors’ view of real estate as an investment opportunity from a risk return standpoint, declined from 5.4 to 4.9 over the past 12 months. Institutional investors cited frothy valuations, geopolitical unrest, possible interest rate increases and global capital markets volatility as causes for concern.
Reflecting institutional investors’ decline in confidence, the report reveals that portfolios remain approximately 100 basis points under-invested relative to target allocations. While higher-returning valued-add strategies remain the strong preference for institutions, 60% of those surveyed signaled an increased appetite for defensive debt and private credit strategies.
As it relates to investment vehicles, closed-end funds are the most preferred by institutions followed by open-end funds. Moreover, 31% of institutional investors reported that environmental, social and governance (ESG) factors are influencing their investment decisions.
Worldwide, institutional real estate portfolios generated an average annual return of 8.6% in 2016, down from 11.0% in 2015. However, investment returns exceeded targeted returns by 20 basis points and remain well ahead of global return indexes for real estate. The trailing five-year average annual investment return was 10.4%. Institutions in the Asia Pacific region achieved the highest average annual return in 2016 at 9.3%, followed by the Americas at 8.7%.
Dustin Jones, Director of the Baker Program in Real Estate at Cornell University, commented: “The Allocations Monitor provides an unparalleled look into how, where and why institutions are allocating capital to real estate. It has proven to be a valuable tool for institutional investors in the development of portfolio allocation strategies and peer benchmarking of returns, and for investment managers in business planning and product development.”
The Institutional Real Estate Allocations Monitor includes research collected from 244 institutional investors in 28 countries, with total assets under management exceeding US$11.5 trillion and portfolio investments in real estate totaling approximately US$1.1 trillion.