For the first time in over a decade, institutional investors have lowered their target allocations for real estate, signaling a significant shift in strategy amidst persistent economic pressures. A new report reveals that the average target allocation fell by 10 basis points to 10.7% this year, a move influenced by global geopolitical concerns, inflation, and the high cost of capital.
This marks the first decline recorded since Hodes Weill & Associates and Cornell University’s Baker Program in Real Estate began their annual survey in 2013. Despite the dip, experts suggest this is not a sign of investors abandoning the sector, but rather a temporary adjustment to a challenging market environment.
Key Takeaways
- Institutional investors' average target allocation to real estate dropped from 10.8% to 10.7%, the first decrease in the 13-year history of a major industry survey.
- The decline is attributed to geopolitical instability, persistent inflation, and elevated capital costs that have slowed the market.
- Investor conviction is rising, with a market bottom likely reached and a projected rebound in allocations for the coming year.
- Alternative assets, particularly private credit and infrastructure, are attracting capital that might have otherwise gone to real estate.
A Notable Reversal in a Decade-Long Trend
After years of steady increases, the institutional appetite for real estate has shown its first sign of contraction. The average target allocation had remained stable at 10.8% for the previous three years, making this year's 10-basis-point reduction a noteworthy event. Back in 2013, when the survey first launched, the average target stood at just 8.9%.
The prolonged market downturn, which began when interest rates climbed sharply in 2022, has created an environment of low transaction volume and reduced distributions to investors. This has had a direct impact on how institutions view their portfolios.
“I think it’s very significant. [But] what I would say is we don’t think institutions are abandoning their allocations to real estate.”
According to Doug Weill, co-founder of Hodes Weill, the context is crucial. While the percentage target has ticked down, the overall pool of institutional capital continues to expand. “Year-over-year, we’re seeing continued growth in the quantum of capital available for real estate,” Weill noted. This means that even with a slightly smaller slice of the pie, the total capital available for real estate investment remains substantial.
Underallocated but Optimistic
The average investor is now 90 basis points under their target real estate allocation, a significant increase from 60 basis points last year. This gap suggests there is pent-up capital waiting to be deployed once market conditions improve.
A Divergent Global Response
The reduction in real estate targets was not uniform across all investor types or regions. The data reveals a complex picture of how different institutions are navigating the current economic climate.
Investor Types Show Different Appetites
Some of the largest adjustments came from specific investor categories. Insurance companies led the pullback, reducing their targets by a significant 40 basis points. They were followed by sovereign wealth funds (-30 bps), endowments (-20 bps), and public pensions (-10 bps).
The size of the institution also played a role:
- Investors with less than $50 billion in assets under management cut their allocations by an average of 100 basis points.
- Larger institutions with over $50 billion in assets made a much smaller adjustment, reducing targets by only 20 basis points.
Regional Strategies Diverge
Geographically, the response varied widely. European investors held their allocations steady, showing resilience or a different market perspective. In contrast, American institutions reduced their targets by 40 basis points.
The most substantial shift occurred among Asia-Pacific investors, who lowered their targets by 100 basis points. Weill suggested this could be part of a strategic pivot towards other alternative assets, like infrastructure, as many institutions in the region are still maturing their investment portfolios.
The Lure of Alternative Investments
Real estate is facing stiff competition for capital from other asset classes. When asked which alternatives were most likely to pull allocations away from real estate, survey respondents pointed to:
- Private Credit: 60%
- Infrastructure: 59%
- Private Equity: 48%
The appeal of these alternatives, particularly private credit, has grown in a high-interest-rate environment.
Signs of a Market Bottom and Renewed Confidence
While the headline figure shows a decline, the underlying sentiment among investors appears to be improving. The report suggests that the market may have already hit its lowest point, with a recovery on the horizon.
Investor conviction in real estate, rated on a scale of 1 to 10, rose to 6.4 this year, up from 6.3 in the previous survey. This is just shy of the 6.5 peak recorded in 2021, indicating that confidence is returning. Weill attributes this renewed optimism to an increase in liquidity and transaction activity observed since the third quarter of last year.
“It might be flat, or we see moderate growth next year, but maybe we’ve hit a bottom here,” Weill commented. “The positive side is institutions are now meaningfully underallocated, and their conviction is rising.”
Looking Ahead to a Rebound
The survey indicates that this year's dip is likely to be short-lived. Respondents anticipate raising their target allocations by an average of 10 basis points next year, which would restore them to the 10.8% level seen from 2022 to 2024.
This expected increase will also be uneven. Public pensions and sovereign wealth funds are projected to lead the way, both planning 10-basis-point increases. However, insurance companies are expected to continue reducing their exposure, likely due to the ongoing high cost of capital and pricing for core assets.
The combination of rising conviction and a significant amount of undeployed capital suggests that as market clarity improves, investment activity in the real estate sector could see a notable resurgence.
