Our investors are motivated to achieve a range of outcomes, with multiple factors influencing their decisions. Their focus may be on generating returns, preserving long-term wealth, matching liabilities, or capturing long-term structural change in society. The considerations are infinite. These motivations can also change over time.
Investors have a significant opportunity to fulfil a broad spectrum of objectives through real estate allocations. While physical rented buildings offer a simple capital and income return, there are many other ways that investors can access returns derived from underlying properties. Investment motives are also becoming more multi-dimensional, with a greater focus on environmental and social impacts. We believe the ability to impact the physical world is a growing motivation for investors to consider real estate.
Three key factors that influence real estate allocations
We spoke to our investment managers to understand what solutions their vehicles provide and what motivates their investors to allocate to real estate. Our paper highlights the three common factors that are influencing our clients’ decisions.
1. Risk, reward and return dynamics
This is the most important factor as an investor’s risk-and-return requirement must be met for an allocation to deliver. Real estate has the benefit of offering both capital and income returns. This key quality means it has a low correlation with bonds and equities and can offer the diversification benefits that many investors are looking for. However, every access point to the asset class carries different levels of risk exposure and not every fund is a suitable solution.
2. Scale
Whatever your motivation, scale and capacity matter. Not all investors have the funds needed to accumulate their own diversified balanced portfolio. Others don’t have the in-house expertise to source assets, develop them, and manage a strategy over time. They need to rely on specialist managers and funds to do that for them. Some vehicles will work better for some than for others. The beauty of real estate is that it provides a range of solutions to fit every investor, regardless of their scale.
3. Market performance drivers and ESG.
The market matters. All the contributors to our paper talked of the fundamentals underpinning the decision-making within their vehicles. To get the best out of what real estate has to offer, vehicles need to respond to market forces. Tenant demand; supply pipelines; liquidity; climate risk; environmental, social and governance (ESG) factors; and other regulations all influence performance and investors’ appetite. From long-term balanced funds to tactical value-add strategies, every approach needs to have a close eye on the drivers of performance and turning points.
What are the key characteristics of different real estate vehicles?
Not every real estate access point will satisfy investors’ objectives and answer their motivations. Some are better equipped to deliver than others. The business areas we spoke to offer certain characteristics that govern the suitability to each objective. The summaries below highlight some of those key factors.
Direct funds or segregated accounts
These funds offer institutional investors long-term options across different geographies, sectors or risk profiles, but with generally lower levels of liquidity. Single country, or internationally diversified options and sector-specific plays are available. There are also risk angles, such as lower volatility long-income funds at one end of the spectrum and value-add funds at the other. Investors in these funds are typically domestic or international institutional investors, insurers and pension funds. They are looking for direct real estate exposure through a professionally managed fund.
Listed real estate investment trusts (REITs)
These offer investors more liquidity, but at the expense of higher short-term volatility. While this can be seen as a risk on a short-term basis, it also allows investors to be more tactical with the timing of their allocations. Specific sector and geographic strategies are fairly common across the REIT landscape, allowing investors to target thematic trends. While correlations with broader equity markets are high on a short-term basis (month-on-month), listed real estate has a higher correlation with direct real estate performance over the longer term (a five- to 10-year period). This means that these vehicles are popular with a wide range of investors, such as those looking for short-term performance or a more cost-effective exposure to the long-term performance of real estate.
There are REIT funds that offer investors access to specialist managers, who can make tactical allocation decisions across the listed funds universe. Active exchange traded funds (ETFs) are also being launched in this space, which target modest outperformance compared with the global REIT funds index.
Indirect multi-manager vehicles
These provide investors with access to underlying real estate returns, but with the ability to trade in and out of funds at a unit price that moves independently to underlying valuations. These vehicles are more suitable for institutional investors with medium- to long-term strategies. They allow investors to target much broader sector, geographic and risk strategies with a relatively small investment. Experienced managers can pool a range of investments to meet a broad risk-and-return target, while having the opportunity to trade units and adjust exposure on the secondary market.
Commercial real estate lending
While this can be considered part of the private credit investment universe, the importance of the underlying real estate fundamentals means it is very much part of the asset class ecosystem. Real estate debt is increasingly offered by non-bank lenders, such as commercial real estate debt funds. These funds offer investors a consistent cashflow with a differentiated set of risks. Unlike direct real estate – where risk is more closely tied to economic growth, construction pipelines and other market factors – risk in the debt space is much more focused on the creditworthiness of borrowers and the underlying tenants in their assets. While tighter credit conditions are often a negative force for equity real estate performance, the opposite can be true for debt strategies. This means that these vehicles can be a natural diversifier within real estate allocations.
Private markets
We also gathered views from our colleagues in private markets, who are running funds with public and private real estate exposure. For their investors, there are three key attractions of having a real estate allocation. Firstly, real estate has a low correlation with their other target asset classes and brings diversification. Secondly, the sector enables multi-asset strategies to capture very tangible megatrends and ESG themes in the buildings that support the economy and society. Lastly, the consistent cashflows the asset class produces help to cover other positions in the portfolio where liquidity is needed.
Real estate solutions offer something for everyone
Real estate vehicles can provide solutions that suit most investors’ objectives. Each access point to the asset class carries different considerations, risks, and return potential. Not all vehicles are suitable for all investors. What is clear from our discussions is that our investors are very tuned-in to the changing drivers of performance and the risks confronting the asset class. We believe that real estate will continue to appeal to a wide range of investors with different motivations in the future.
The built environment has a huge role to play in a sustainable future, not just in terms of decarbonisation, but in supporting a more healthy and functional society too. This will create exciting new opportunities to invest in the variety of fund types available to our clients.