Institutions continue to increase target allocations to real estate, with the expectation that attractive buying opportunities will emerge over the next several years.

That’s according to 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 the report finds that 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.

The findings are based on responses from 173 institutional investors from 34 countries that own real estate assets valued at c.$1.1 trillion.

In Association with

The decline in investor confidence noted in the survey’s Conviction Index 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 has declined from a ten-year high of 6.5 in 2021 to 6.0 in 2022.

Hodes Weill says that on a trailing five-year basis, institutions have seen an average annual return of 9.9%.

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,” says the report.

“One in three 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, according to Hodes Weill.

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.

Distress opportunities

Douglas Weill, managing partner at Hodes Weill & Associates, commented: “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 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.”

Institutions universally expressed declining interest in the UK, with 53% of investors reporting actively allocating to the region, down from 61% in 2021.

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.

The report states: “A heated movement of anti-ESG rhetoric has made its way into US 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.”

To download the report, click here.