Several changes within the real estate industry, from trade wars passing costs onto new construction to a lack of safety on government policies to rising cap rates, is leading institutional investors to rethink their real estate allocations, now that it’s no longer seen as an inflation hedge. 

“A lot of structural changes are afoot within the industry and causing institutional investors to recalibrate how they see real estate as an asset class,” Cameron LaPoint, assistant professor of finance at Yale School of Management, told Institutional Investor. “I’m seeing a lot more interest in middle risk assets, like core, core plus, as opposed to the more distressed assets coming out of Covid.” 

After the pandemic lifted industrial and residential rentals in 2021 and 2022, the narrative of real estate as a great inflation hedge broke in 2022 when inflation spiked but income assets performed poorly over the next two years. While rates were up, the expectations for long-term inflation stayed low, so landlords couldn’t justify raising rents.  

Joseph Harvey, CEO of Cohen and Steers, said that “real estate is definitely still a diversifier,” but the sectors are being driven by different fundamentals.  

Cohen and Steers’ head of real estate strategy and research Seth Laughlin said interest rates haven’t been driving real estate markets as much as investors think. Instead, the market has placed a premium on growth, whether it's in the private or public markets. Investors are chasing the AI trade, for example, and undervaluing real estate, which is driven by income. “It reminds me a lot of what we saw at the end of the tech bubble,” Laughlin added. 

Putting AI data centers aside, Laughlin sees the bulk of institutional capital focused on two main sectors in core real estate: industrial and multifamily. “That is where there's been the most enthusiasm,” he said. The pandemic was also a shock to the senior housing sector, which he thinks will be “as strong as it’s ever been over the last 20 years.” 

Cohen and Steers thinks investors are overallocated in apartments. “I think the enthusiasm for the rebound in apartment fundamentals has been overstated,” Laughlin said, pointing to falling values and rising cap rates.   

LaPoint also sees bright spots. Not only is A-plus office recovering in the New York City and San Francisco Bay Area markets, but suburban office is also a recent darling “that’s getting a lot of the deals these days.” The professor recently published a research paper with Gustavo Cortes from the University of Florida showing that local building permit activity can help predict future financial market conditions.