Major funds are continuing to shift investment efforts toward commercial real estate markets, a signal that stable returns and reliable cash flows are increasingly a priority after a decade of growth for financial markets.
The University of California (UC) endowment recently announced a greater focus on real estate. Out of the roughly US$500 million cash position that the UC system invested in the third quarter last year, 60 percent went into property, said Edmond Fong, the Senior Managing Director of Absolute Return Investments in the UC Office of the President, in a televised meeting.
California’s state university system is not alone in increasing its allocations to real estate. Yale University’s endowment allocated 15.1 percent between 2013 and 2017. The University of Pennsylvania endowment’s latest report showed that its target allocation to real estate had increased several percentage points over the past decade.
“Real estate in general is seeing an uptick from institutional investment allocations, and that includes endowments,” says Jerry Cain, Head of Funds Advisory – Americas with JLL. “We’re late cycle and investors want inflationary protection and durable cash flows. There is definitely strategic thinking around, ‘How do we position our portfolio for a potential downturn.’”
It’s not just university endowments, either. Funds worldwide are putting more money into real estate in a hunt for stable returns. Real estate in institutional portfolios increased to 10.4 percent in 2018, up from 8.9 percent in 2013, according to a recent survey.
Sign of the times
Commercial real estate allocations have been increasing as jitters appear in other markets, like stocks and bonds. Quantitative tightening – the process where the Federal Reserve is decreasing liquidity – along with rising inflation, heightened political uncertainties and international trade tensions are weighing on global economic growth prospects. Equity and bond markets are expected to see increasing volatility in this environment.
Real estate markets are benefiting, in part due to the perception of being a stable, long-term alternative, Cain says. The sector has shown little correlation to stocks and bonds, with changes in property values generally lagging economic performance.
Real assets, including real estate, also have “inflation protection because rents reset,” he says. “Endowments and other institutional investors keep a watchful eye on this and utilize real estate as an inflation hedge.”
Not always easy sailing
While funds are increasingly allocating more capital to commercial real estate, finding product to buy can be a challenge. Competition for high-yielding property is fierce after a decade-long property boom.
Dry powder — or unspent capital in a fund – reached another record level in 2018. For private equity, that entailed almost US$2.1 trillion as of June 30, 2018, up from $1.8 trillion as of December 31, 2017, according to Preqin.
Still, real estate is unlikely to lose its luster, as the market has continued to mature.
“It’s important to identify Fund Managers that are differentiated and can be nimble while navigating this competitive real estate environment,” Cain says. “There are still attractive investment opportunities and it’s important to work with investors who can unlock value.”