With uncertainty surrounding investment decisions across every asset class, almost one quarter of all investors plan to decrease their allocations to real estate globally between 2023 and 2024.
This is barely offset by the 27% of investors globally that are planning to increase allocations over the same period, revealing a muted outlook for the industry.
According to the 2023 Investment Intentions Survey published today by ANREV, INREV and PREA, European investors are the most cautious, with 37% planning to decrease allocations during the period – significantly above the 20% and 5% equivalent for their North American and Asian Pacific peers.
However, the current average allocation to real estate globally is 10.2%, only slightly below the average target allocation of 10.4%. The equivalent gaps narrowed significantly for European and North American investors, related to the dominator effect as other asset classes fell further than real estate during 2022. This effect has increased current allocations, and some investors from mature global economies could be technically over-allocated to real estate. On average, only European investors are above target allocations.
Although the current drop in investor sentiment is sharper than during the Covid-19 crisis, the near-term allocation outlook reflects the fact that, as a private market, non-listed real estate lags other asset classes in terms of the speed and degree of repricing.
Return to core
The prevailing mood of caution has prompted a return to core as the preferred investment style for 2023. European investors are once again the most risk averse, with 57% opting for core when investing in their region. They also have the lowest preference for opportunistic strategies, at just 8%. In Europe, the shift to core resembles the pattern seen in 2008 and 2009 – albeit, less sharp.
Interestingly, Asian Pacific investors targeting Europe reported a substantial increase in preference for opportunistic strategies, perhaps looking to increase their European portfolios at a discount.
Rise of non-listed debt
When looking at Europe, on an equally weighted basis, almost all access routes into real estate are expected to see an increase in allocations, with the exception of listed real estate and derivatives. Non-listed real estate debt takes the top spot, with a 62% net increase position. Joint ventures follow, with 39% net increase position, while directly held real estate, separate accounts, and non-listed real estate funds stand at around 30% net increase.
Weighted by investors’ real estate AUM, preference for non-listed real estate debt jumps to over 75%. Conversely, non-listed real estate funds and joint ventures slip into net negative territory at -16% and -6%, respectively.
The Survey indicates that smaller investors prefer vehicles, such as funds, which offer them access to specific knowledge of a manager, diversification, and scale. However, larger investors prefer to have more control. The overall preference for non-listed real estate debt – which is shared by small and large investors alike – supports the conclusion that all investors are looking for less risky strategies, with senior debt, in particular, well placed to meet that need.
More defensive strategies across markets and sectors
The search for lower risk is also reflected in investors’ geographic and sectoral preferences. Top picks for European investors are Germany (50%), Netherlands (44%), France and the UK (both 39%).
Office, residential and industrial/logistics remain the preferred sectors for all investors targeting Europe, however below their seven-year averages. At nearly 70%, offices took the top spot which, though possibly counter-intuitive, can be partially explained by non-European – and Asian Pacific investors in particular – identifying it as the sector of choice when accessing Europe. Residential maintains its second-place position, confirming the structural shift toward this growing institutional market which offers a high and stable income return and a strong countercyclical strategy. At 46%, industrial/logistics – last year’s top preference – slipped to third place. This may be no surprise as the sector is starting to see the reversal of many years of consistent outperformance, sharp yield compression and relatively high rental growth expectations. However, given the sector is underpinned by e-commerce as a megatrend, this may well be a short-term blip.
For European investors, sector preferences line up slightly differently with industrial/logistics and residential in joint first place both at 67%, followed by offices (50%).
Complex mix of issues impacting investment decisions in 2023
There is broad consensus from investors across all regions that inflation, interest rate policy and geopolitical risk are impacting investment decision-making the most.
However, there are strong differences of opinion when it comes to assessing the importance of ESG factors. Over 90% of European investors say that a fund’s commitment to net zero carbon is a key consideration in real estate investment decisions, compared to nearly 70% of their peers in Asia Pacific and 0% of those in North America.
Inflation hedging potential increases in importance
As in previous Surveys, the majority of respondents across all three geographic regions cited the diversification benefits of real estate as a principal driver for allocating to the asset class. However, the last two years have also seen a significant rise in the importance ascribed to inflation hedging. With inflation having been low for many years, investors seemed to have largely discounted inflation risk – something that has changed rapidly over the course of 2022.
Iryna Pylypchuk, INREV’s Director of Research and Market Information said: ‘The 2023 Investment Intentions Survey paints a clear picture of the difficult operating environment that investors are continuing to navigate. The higher for longer interest rate environment almost demands revisiting and reinstating the case for non-listed real estate as an asset class. However, despite the muted short-term outlook, the income return, partial inflation hedge, and long hold qualities of the asset class will continue to support high level allocations for investors able to circumvent technical allocation breaches.
‘The move towards ESG and non-listed real estate debt are now being supercharged by regulation and/or the need to service the market. So, despite the headwinds, European non-listed real estate looks to be progressing to a fundamentally more resilient, futureproof, and increasingly diverse investment proposition. What’s more, the cautious approach being adopted by European investors is a clear sign that market participants are realistic and preparing to embrace the challenges on the horizon.’