HNW investors shift toward real estate debt

More high-net-worth investor capital is moving toward US commercial real estate, with market participants telling Real Estate Capital USA that the investor group likes the characteristics of debt investments in particular because of higher yields and stability.

“Real estate as an asset class is a growing segment of a high-net-worth investment portfolio,” Bernie Wasserman, president of Miami-based real estate investment firm Participant Capital told Real Estate Capital USA. “High-net-worth investors are looking at alternatives, particularly real assets, for the sector’s return potential and stability.”

The shift toward alternatives can also be attributed to public equities in the US becoming increasingly expensive at a time when fixed-income yields are also at historic lows, according to a February report from KRR. The report found that high-net-worth investors allocated larger shares of their portfolios to real estate and private equity in 2020 than compared to the same period in 2017, with each asset class seeing roughly 3 percent gains in allocation. The report also found real estate accounts for 22 percent of high-net-worth investor portfolios, making it the second-largest holding in alternative investment portfolios. Private equity investments make up about 54 percent of portfolios, the report found.

Alex Jeffrey, global chief executive officer at Savills Investment Management, is seeing this shift in real time.

“We have seen an uptick in interest from high-net-worth investors while, historically, this investor group has focused on higher-returning and higher-risk strategies such as special situations, or distressed debt,” Jeffrey told Real Estate Capital USA. “This is consistent with what’s happened over the years, even on the equity side, where typically high-net-worth investors focused on the more high-yielding options, opportunistic investments.”

The current economic and geopolitical environment could also affect where capital is allocated within real estate, Jeffrey said.

“We’re seeing a changing macro backdrop with increased volatility in the public markets as a result of geopolitical conflicts, as well as inflationary concerns,” added Jeffrey. “Our sense is that we may see a shift in demand towards performing loan strategies and we would expect it to be in the higher-yielding or mezzanine space with returns in the sort of high single digits range rather than senior or core lending.”

Turning point

The asset class first crept into the foreground for high-net-worth investors around the time of the global financial crisis.

“Now, hard assets like real estate are better positioned to weather short-term volatility since they don’t fluctuate like liquid assets,” said Participant’s Wasserman. “As a non-correlated asset, real estate can better withstand a down market.”

Within the sector, multifamily is seen as one of the most stable sectors in which to invest, noted Wasserman. “Multifamily was one of the best-performing real estate asset classes during the pandemic because it provided a reliable stream of income and valuations supported by strong demand, limited supply growth and record-low interest rates. The asset class has grown in acceptance since the global financial crisis by its strong performance during the pandemic and the desire [from investors] to own hard assets during times of geopolitical uncertainty like what we are experiencing today with the Russia-Ukraine conflict.”

A late-2020 report from the Boston-based Van Keuren Family Office Real Estate Institute found that investor interest in real estate has been spurred by the covid-19 pandemic. The report found that 27.6 percent of respondents said they were going to invest more in real estate in 2021 while another 39.5 percent were going to keep their plans exactly the same. Only 3.95 percent reported they were going to cut back. The number one property type is multifamily with 76.4 percent of families that like to invest in it. This year, the second area of focus is industrial, targeted by 55.5 percent of families, the report found.

According to KKR, 81 percent of institutional investors are thinking in a similar way. The firm found this percentage of investors is planning on increasing their alternative investment holdings by 2025.

“Many institutional investors are looking to take some of their holdings from expensive public equities or low-yielding debt and put them in alternative investments,” said Andy Puckett, professor of finance at Haslam College of Business at the University of Tennessee. “Alternative asset classes are often marketed as being uncorrelated, or having relatively low correlations, with publicly available investments such as stocks and bonds. There is also a suggestion that some of these alternative investments have high returns relative to their risk. Both claims are more controversial than most in the industry would have you believe. Ultimately, I think the allure of alternative investments for the ultra-wealthy is their exclusivity, not the true expected risk-return profile of the investment.”

With current volatility brought on by Russia’s invasion of Ukraine, higher interest rates and the specter of inflation, appetite from this type of investor for real estate is only expected to gain more traction.

“For the broader real estate market, we already have high inflation, we are facing a rising interest rate environment and our economy has been booming, but insert a war and it can have a tremendous impact on economic activity, which is the biggest concern for real estate,” said Wasserman.

Andrew Singer, principal and co-Lead of Avison Young’s Tri-State Debt & Equity Finance group, believes that while more high-net-worth investors are going into real estate, this group has always been a key part of the real estate investment space.

“What we’re seeing now is not a titanic shift, because those investors you’re describing have been in the real estate world for many, many years,” said Singer. “Their appetite is a bit stronger now than it has been because the conventional wisdom is that inflation will help the bottom line on real estate as the net operating income of properties and income will go up. And so, inflation is good for real estate, typically.”