Bad press and too few deals: investors aim to cut real estate allocation

Institutional investors’ allocations to real estate look set to drop next year, as big names struggle to “defend its place” in their broader strategies. Hodes Weill & Associates and Cornell University’s 12th annual Institutional Real Estate Allocations Monitor found that target allocations held steady at 10.8% in 2024, but that institutions expect to lower their targets by an average of 10 basis points next year in favour of asset classes including private credit and infrastructure. The study quizzed 186 institutional investors in 25 countries with combined portfolio investments in real estate valued at roughly $1.4tn (£1.1tn). Responses from investors – anonymised in the paper – shed light on some of their concerns about the outlook for real estate deals. Past the peak “Real estate generally has a lot of bad press at the moment, which makes it challenging to defend its place in a multi-asset portfolio,” said an executive at a European insurance company. An endowment fund executive operating in the Americas added: “We are looking at a lot of opportunities because the rise in interest rates has stressed owners, but we are just not seeing a lot of compelling deal flow relative to other asset classes.” Another American dealmaker said they were “patiently waiting for cracks of distress to materialise” and “investing selectively in niche segments in the interim”. Hodes Weill & Associates said write-downs in real estate portfolios from 2022 peaks have led to “a significant shift” in allocations year-over-year. Almost 40% of institutions had reported being over-allocated to real estate in 2023, but half say they are now under-allocated to the asset class. There was more optimism when investors looked further ahead. The report authors said institutions have remained “largely on the sidelines” for the past two years due to worries about inflation, interest rates, low deal volumes and economic uncertainty. “As transaction volumes rebound, institutions report that they are gaining conviction about a market bottom and the opportunity to allocate capital to new investments,” they added. Douglas Weill, managing partner at Hodes Weill & Associates, said: “Despite persistent challenges in the market, commercial property price index data suggest that real estate valuation metrics have bottomed – and in some cases, they are showing signs of rebounding. “While negative returns have materialised as expected and will likely continue as institutional portfolios are marked to market, broader macro trends, including continued interest rate cuts and signs of decelerating rates of inflation, are driving transaction activity, which should help to stabilise valuations.” Optimism in EMEA European partner Matt Hershey noted that Europe and Middle East-based investors have shown the highest conviction for new investments. “We believe this can be attributed to strong property market fundamentals with an increasingly clear capital markets picture going forward,” he said. “This is despite the fact that EMEA-based institutions experienced the most challenging performance in 2023. Overall, these institutions report that they are optimistic about achieving their target return of 7% in 2024, with a clear preference for core investments over the next cycle.” Hopes and headaches When asked to outline the risks that could affect investment decisions, interest rates remained the greatest concern, although the percentage of institutions highlighting that worry decreased slightly to 85% from 91% a year ago. Asset valuation levels were the next biggest issue, cited by 65% of institutions compared to 52% in 2023, followed by concerns around capital availability and borrowing constraints, both of which are causing more headaches than a year ago. Covid-19 finally fell off the list of top concerns. “Recent interest rate cuts in the US, Europe and the UK provide greater potential for future borrowing and greater potential for buyers to meet seller pricing of assets,” said a pension fund executive in the Americas. “Real estate transactions should pick up over the next 12 months. The narrowed selection of property types to mostly residential and industrial means that too much capital is chasing the same assets, making pricing in those sectors often too high for a deal to pencil out. Buyers need to be quite selective regarding location and quality of properties in today’s investment environment. “Diversifying acquisitions on an international basis may contribute to a healthier real estate portfolio.” Photo © Valentin Wolf/imageBROKER/REX/Shutterstock