Institutional investors often consider real estate as an important part of a balanced portfolio. It provides a bit of diversification while delivering superior returns over time. While retail investors and institutional investors often have different motivations, the average investor can learn a lot from what the giants do.
A trillion-dollar investment
Since 2013, Hodes Weill & Associates has created a report that surveys how institutional investors are feeling about real estate. The Institutional Real Estate Allocations Monitor this year took place over the summer, which means that the feelings on real estate may have reflected two factors: The first is the shock factor of the pandemic, and the second is the growing awareness that there may be major opportunities coming in real estate. The participants in the survey represent $12.6 trillion assets under management globally, with around $1.3 trillion invested in real estate.
Real estate continues to be a bigger piece of institutional portfolios, but the amount of institutional investors invested in real estate dropped to 85% in 2020 from a high of 96% in 2019. This is likely due to a combination of factors, not all of which are COVID-19 related. Before the pandemic took hold, there were concerns that real estate's long cycle of profitability might be coming to an end. Institutional investors have different needs. Some, such as insurance companies or foundations, may prioritize stability, while pensions and endowments may be seeking a higher rate of return.
Average target allocations were up to 10.6% in 2020 and are expected to be up to 10.9% in 2021. These real estate investments resulted in an average return of 8.3% in 2019 but may drop in 2020 due to the impact of the pandemic. And yet, investors remain under-allocated relative to their target goals. However, growing appetite for real estate, combined with suppressed activity in 2020, could mean that pent-up demand will be unleashed in 2021.
One interesting trend is that institutions are focusing on more strategies that can deliver a higher return. The survey looked at the type of deals that these institutions favor and found that investor appetite for higher return strategies has grown. Value-add investments that involve significant redevelopment in order to increase returns are the most popular. This year, however, the preference for value-add deals dropped from 91% to 84%, while the interest in opportunistic deals, which generally involve more risk but often deliver a higher rate of return, rose from 69% to 72%.
ESG becomes more of a consideration
We've talked on this site before about ESG investing among retail investors, but it has an even bigger impact among institutions that are accountable to a wider pool of individuals. According to the survey, 47% of institutions have an ESG policy in place, a big leap from just five years ago when the number was 33%. However, only 36% of institutions from the Americas have these types of policies in place.
While it's unclear how much these policies are truly influencing investing, ESG and diversity issues are likely to continue to play a bigger role in the decisions these institutions make going forward. ESG includes not just issues like climate change but also concerns such as affordable housing. Many institutional investors are finding that their stakeholders are asking more questions about how they are achieving profits while also still contributing to social good.
The Millionacres bottom line
Institutional investors see potential profits in distressed assets. This may lead to more investing in real estate. The survey reflected that 29% of institutions report that they expect to increase target allocations over the next 12 months, up from 24% one year ago. Retail investors should take comfort in the fact that institutional investors are getting ready to make big moves in real estate in 2021.