Investor sentiment toward real estate decreased for the first time in five years as persistent inflation, rising interest rates, and heightened geopolitical tensions continue to threaten the global economy.
Thirty-two percent of institutional investors are overallocated to real estate in 2022, a more than threefold increase from last year, according to the latest annual Institutional Real Estate Allocations Monitor report, which is published by Hodes Weill & Associates and Cornell University’s Baker Program in real estate. Overallocation to private assets has been common this year, as the corrections in the public markets have yet to be reflected in investors’ private market valuations.
In the first three quarters of 2022, real estate funds raised a total of $107 billion, the slowest first-to-third-quarter fundraising pace since 2013.
The result was based on a survey of 173 institutional investors with a total of $1.1 trillion invested in real estate assets. Most of the survey respondents are public and private pension plans, endowments, and foundations. The survey was conducted between May and October.
The slowdown in cross-border deals also signals that investors are taking a more cautious approach to real estate investing, according to Douglas Weill, founder and co-managing partner at Hodes Weill & Associates. In North America, 57 percent of real estate investors are investing outside of their domestic region in 2022, down from 63 percent in 2021, according to the report. “The real estate markets have become very global in nature over the past 10 to 15 years,” Weill told II in an interview. “[But] we expect cross border capital flows [to] be at a lower level for the foreseeable future.”
Despite the difficult environment, however, the prospect for real estate investing isn’t all doom and gloom. Even amid overallocation concerns and declining investor sentiment, real estate assets continue to serve as a hedge against inflation and are expected to outperform other alternative assets, such as private equity. The asset class has also shown that it can generate high investment returns on a long-term basis, with an average five-year gain of 9.9 percent, according to the report. Studies have also shown that the best real estate returns tend to follow recessionary periods.
Investors who are downbeat about commercial real estate may produce some good investment opportunities.
“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,” Weill said. “If market volatility leads to distress and dislocation, the next several years may prove to be good vintage years for capital deployment.”
According to the report, the average target allocations to real estate rose to 10.8 percent in 2022, up 10 basis points from last year. Target allocations to the asset class have been steadily increasing since 2013 and are expected to reach 11.1 percent next year. The most notable target-allocation increase comes from the Teachers’ Retirement System of Louisiana, which adjusted its target allocation to real estate from 10 percent in 2021 to 15 percent in 2022, according to the report.
“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,” Weill said.