Collapsing equities and fixed-income values have contributed to a spike in institutional investors becoming overallocated to private real estate, according to Hodes Weill and Cornell University’s annual Allocations Monitor white paper.
The report, released this week by Hodes Weill and Cornell’s Baker Program in Real Estate, found the denominator effect – where valuation movements for certain asset classes in institutional portfolios significantly impact allocation levels in others – is contributing to a notable rise in investors finding themselves overallocated to real estate.
According to the research, which this year included 173 institutions responsible for approximately $1.1 trillion of real estate globally, the number of institutions reporting overallocation has more than tripled year on year, with 32 percent of institutions now invested above their target allocations, compared to just 8.7 percent in 2021.
The finding adds further paint to a picture already displaying decreasing liquidity for real estate markets around the world, with credit markets also generally drying up as lenders wait to ascertain where interest rates will settle. “Almost every other asset allocation was down: public equities, fixed income, private equity and other alternatives have taken a beating whereas real estate has held up and you haven’t seen meaningful write-downs there yet,” Weill told affiliate publication PERE.
He also blamed the overallocation outcome on a “numerator effect” as a result of the real estate sector’s strong performance in 2021. According to the survey, now in its 10th year, the sector generated a total return of 17.1 percent in 2021, significantly bouncing back from the 5.9 percent return recorded in 2020.
“A combination of those things resulted in institutions in many cases being overallocated,” Weill said.
How these overallocations will be handled by investors, however, depends in part on their levels of current conviction for the asset class, he said. The Allocations Monitor recorded a decrease in sentiment year on year with investors concerned about today’s high inflation, geopolitical tension and rising interest rates and not keen to invest in such an uncertain environment. The Monitor’s scoring system has investors rate on a scale of one to 10 their view of the investment opportunity in real estate from a risk-and-return perspective, one being the least favorable, 10 being the most favorable. This year, investors averaged a score of 6.0 compared to 6.5 last year.
Consequently, some investors are seeking liquidations, with certain open-ended funds seeing increased redemption requests. “They are trying to get capital out before write-downs come into play; to redeem at yesterday’s price versus tomorrow’s price,” Weill said.
He continued: “Institutions are incredibly cautious right now. Some investors have a hard line. If they are overallocated, they stop. Some have flexibility and a margin. Those are asked not to liquidate, just to stop investing or slow down their pace of investment.”
Not all investors are seeking to pause or reduce their activity, however. Weill cited how certain institutions are seeking to capitalize on today’s lower liquidity levels by increasing their allocations to take advantage. In certain cases, they are also buying into REIT markets which have traded down significantly, and into debt markets, either as investors in debt funds or becoming lenders themselves.
Ultimately, Weill said, much depends on the extent of private real estate write-downs: “Now, we’re in this moment when real estate is holding up reasonably well and operating fundamentals are reasonably strong. It’s a pricing and capital markets event the industry is dealing with. We just need to see where prices and the cost of debt settles.”
In the meantime, Weill pointed to how average target allocations had continued to grow. According to the report, the average target allocation in 2022 was 10.8 percent, up 10 basis points on last year. Target allocations have grown by 190 basis points since Hodes Weill and Cornell University first published the Allocations report in 2013.
The 173 investors that responded to this year’s report represent 6 percent of the approximately 3,000 investors surveyed, a sample size determined by the two organizations to be representative of the industry’s institution base.