Institutions are decreasing core and value add allocations to make room for distress in their portfolios.
It is a truism that institutional investors in commercial real estate tend to play it safe, preferring core land value-add strategies and properties in gateway markets. In recent years many of these funds have pushed the envelope to consider secondary market investments but 2020 marked a significant pivot for these funds: a focus on distress.
This, of course, is little surprise given the economic upheaval caused by the pandemic. Many, many investors have lined up to take advantage of such opportunities, even though the pipeline of deals has been less bountiful than expected as lenders worked hard with borrowers to keep loans current.
Still, institutional investors’ appetite for high-return CRE strategies this year is clear, according to Cornell University’s Baker Program in Real Estate and Hodes Weill & Associates eighth annual Institutional Real Estate Allocations Monitor. “While value add strategies remain the strongest preference for institutions globally, investors are shifting a greater allocation of their portfolios to opportunistic strategies in anticipation of market distress and dislocations,” it says.
This shift is occurring even as CRE returns have been higher than anticipated, generating an average 8.5% last year versus a return target of 8.3%. The five-year average return for all institutions outpaced target returns by almost 100 bps.
Making Room in Their Portfolios
Make no mistake, value add strategies will continue to be the most favorable investment strategy for institutional funds going forward, the report notes. It found that 84% of institutions are reporting that they are actively allocating to value add investments. Similarly, 62% of institutions reported allocating capital to core strategies, down from 66% in 2019.
That said, value add strategies declined in popularity, as investors anticipate re-directing capital to invest in higher-yielding, opportunistic real estate, including distressed strategies. “Institutions from all regions reported a decrease in capital allocated towards core and value add strategies, making room in their portfolios to adjust to shifting economic conditions as a result of the global pandemic,” according to the report.
Investor preferences vary by region and by type of institution. While there was a global shift towards opportunistic strategies, the year-over-year increase was largely driven by APAC-based institutions, the report said. 73% of institutions from the region reported they are actively allocating to opportunistic strategies, up from 40% in 2019. EMEA-based institutions were the only investor region to report an increase in their preference for core real estate increasing a nominal two percentage points.
When comparing risk preferences by type of institutions, the report found that public and private pensions were the market leaders in the shift towards opportunistic strategies, reporting increases of 18% and 11% respectively. Endowments and foundations were the least likely to invest in core strategies, at 30%. Core strategies remain in favor with sovereign wealth funds.
Source: “Even Institutional Investors Are Eager for Distress“