Institutions Remain Significantly Under-Invested Relative to Target Allocations

Despite decreased returns in 2020, institutional investor confidence in commercial real estate remains strong, reaching a nine-year high in 2021, according to a study by Hodes Weill & Associates and Cornell University’s Baker Program in Real Estate. Their ninth annual Institutional Real Estate Allocations Monitor shows pensions, sovereign wealth funds, insurance companies and other institutions continue to look to real estate as an important portfolio diversifier, hedge against inflation and source of stable income.  

Actual returns declined significantly in 2020 from 8.5% to 5.9%, owing to a decline in property valuations resulting from vacancies, cash flow risks and uncertainty related to the COVID-19 pandemic. However, the vast majority of institutions are viewing this decline as an episodic event and remain optimistic for 2021, as valuation metrics climb to all-time highs.

This year’s survey measured institutions’ view of real estate as an investment opportunity from a risk-return standpoint. The latest “Conviction Index” increased from 5.9 to 6.5 – its highest point since the survey launched in 2013. This growing confidence can be attributed to strong fundamentals in industrial, multifamily, and niche property sectors such as life sciences and data centers, which are strategies that continue to attract significant capital. The view that there is, or will be, an opportunity to invest in certain sectors or markets that are experiencing distress or dislocation is also driving investor conviction.

 Key Findings of the 2021 Allocations Monitor

• While the growth in target allocations remained moderate year-over-year, institutions expect to increase allocations at a faster pace over the next 12 months.
• Institutional portfolios are under-allocated to real estate by the widest margin over the past seven years, resulting in an acceleration of capital flows to the sector. The level of under-investment, coupled with rising investor sentiment, is accelerating capital flows to the sector.
• Portfolio investment returns under-performed long-term targets in 2020; but investors remain optimistic for 2021 as valuation metrics climb to all-time highs.  Institutions are reporting a strong bounce-back in returns in 2021, as economies re-open and operating fundamentals are showing strength. 
• Investor sentiment increased to a nine-year high, and investors remain bullish about the opportunity to deploy capital. Opportunities exist or are expected arise to invest in certain sectors or markets that are experiencing distress or dislocation is also driving investor conviction.
• Cross border capital flows remain strong, and the percentage of institutions investing outside of their domestic region is on the rise. The long-term trend towards rising cross border investments has returned, as institutions report increased appetite to allocate to strategies outside of their domestic regions. The U.S. remains the preferred destination for international capital flows, followed by continental Europe. Institutions in APAC remain significantly underinvested relative to target allocations and are expected to be very active deploying capital globally over the coming years.
• A growing number of institutions are outsourcing real estate portfolio investments to third party managers. The continued allocation of capital to third-party managers, coupled with appreciating values and income reinvestment, is driving double-digit AUM growth for the asset management industry.
• Higher return value-add and opportunistic strategies remain the strong preference coming out of the COVID-19 pandemic, with US-based institutions showing the greatest appetite for risk. 
• ESG continues to be a major focus of investors, led by institutions in Europe and Australia. With more than 50% of institutions now reporting that they have an ESG policy, ESG is moving from a “nice to have” to “have to have” for managers and their institutional clients.