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Institutional Investors May See Too Much Investment in CRE
A returns performance gap may mean some institutions put the brakes on new investment paces.
The rapid climb in commercial real estate values has been great for investments. But, ironically, because of the denominator effect, it may have been too good for some institutional investors. And that’s bad because these big players might pull back continued new investment due to the denominator effect. At least, that’s the suggested result of a recent study associated with Trepp.
Hodes Weill & Associates and Cornell University’s Baker Program in Real Estate conducted the Institutional Real Estate Allocations Monitor between May and October 2022. The survey was of 173 global institutional investors, including pension plans, insurance companies, sovereign wealth funds, endowments, and foundations with a combined $11 trillion total assets.
The investors had seen their CRE portfolio allocations increase from 10.7% in 2021 to 10.8% this year. Except, the addition wasn’t a planned boost, but rather CRE’s outperformance compared to other investment classes like equities and fixed income, which had a bad year.
Since 2013 the CRE allocation has increased an average 190 basis points. The 10-basis point increase was less than expected, but still in line with average changes since 2018. In the Americas, CRE allocation was 9.9% and expected to rise to 10.3%. Pension plans had the highest allocation of 12.6%. Insurance companies’ average 5.9% was the lowest of the groups but expected to rise to 6.5% by next year.
In the denominator effect, every invested sector represents a percentage of the total portfolio. If there’s a performance gap — often due to a pricing lag between real-time stocks and bonds and more periodic mark-to-market pricing of real estate — then the relatively higher value of one sector means it has a larger slice of the portfolio pie.
The problems come when the portfolio belongs to an institutional investor that has been active in a sector like real estate, which outperformed, and also has a strictly disciplined portfolio allocation strategy. The investor often will pull back on new investments in the winning sector to keep it from becoming an overly dominant part, or possibly even sell part of its holdings.
Trepp separately noted that CRE had the highest reported return in 30 years: an average 17.1%, up from 5.9% in 2020. For 2022, institutions reported a targeted 8.2%.
Survey results showed that institutions looked toward an average 30-basis point increase in target CRE allocations, with 28% projecting increases, down from 33% last year, and 63% planning to keep their current allocations.
That could have serious implications for CRE, which has depended on demand to boost prices.
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