In a major change from the past few years, European investors are expected to look at decreasing their allocation to real estate in 2023, a new Investors’ Intention survey released by Inrev has revealed.
European investors will be targeting a 10.5% allocation to real estate this year, compared to a current allocation of 10.8%, reflecting a 30 bps drop largely owing to what Inrev says is a technical over-allocation to the sector. Contrary to Europe, Asian and North American investors will continue to seek an increase of their allocation, resulting in a 20 bps positive gap between the current allocation of 10.2% and a target allocation of 10.4%.
In general, almost one quarter (24%) of all investors plan to decrease their allocations to real estate globally between 2023 and 2024. This is barely offset by the 27% of investors globally that are planning to increase allocations over the same period. In Europe, 37% of investors plan to decrease their allocation and only 16% is looking to increase it. ‘The good news is however that the fast market correction we are seeing will help erode the denominator effect and minimize its impact,’ said Inrev’s director of research Iryna Pylypchuk during the survey presentation.
The denominator effect – the effect whereby a drastic decrease in the value of other asset classes pulls down the overall portfolio value – has resulted in an increase in investors’ current real estate allocations (as other asset classes fell further than real estate during 2022), with some investors from mature global economies resulting technically over-allocated to the sector. ‘The faster the market corrects, the sooner this effect will go away,’ Pylypchuk said.
Flight to safety
European real estate has recently seen a rapid decline in performance, with European non listed returns reporting the largest quarter-on-quarter decrease in capital values since the global financial crisis (GFC). ‘In uncertain times like this we tend to see a flight to safety, and we are in fact reporting a shift towards core funds in terms of strategy, although it is not quite as pronounced as after the GFC,’ Pylypchuk said.
In terms of preferred investment strategies, investors’ intentions differ depending on where they are domiciled. European investors are once again the most risk averse, with 57% opting for core when investing in their region. They also have the lowest preference for opportunistic strategies, at just 8%.
Interestingly, Asian Pacific investors targeting Europe reported a substantial increase in preference for opportunistic strategies (which increased from 9% in 2022 to 20% in 2023), perhaps looking to increase their European portfolios at a discount.
Rise of non-listed debt
When looking at Europe, on an equally weighted basis, almost all access routes into real estate are expected to see an increase in allocations, with the exception of listed real estate and derivatives. Non-listed real estate debt takes the top spot, with a 62% net increase position. Joint ventures follow, with 39% net increase position, while directly held real estate, separate accounts, and non-listed real estate funds stand at around 30% net increase.
Weighted by investors’ real estate AUM, preference for non-listed real estate debt jumps to over 75%. Conversely, non-listed real estate funds and joint ventures slip into net negative territory at -16% and -6%, respectively.
‘The European debt market universe has doubled in size over the past seven years. However, it remains a very small market and there is a mismatch between investors’ intentions and the supply of product,’ Pylypchuk said.
The survey indicates that smaller investors prefer vehicles, such as funds, which offer them access to specific knowledge of a manager, diversification, and scale. However, larger investors prefer to have more control. The overall preference for non-listed real estate debt – which is shared by small and large investors alike – supports the conclusion that all investors are looking for less risky strategies, with senior debt, in particular, well placed to meet that need.
Offices take top spot
The search for lower risk is also reflected in investors’ geographic and sectoral preferences. Top picks for European investors are Germany (50%), Netherlands (44%), France and the UK (both 39%). Pylypchuk: ‘European investors are to a great extent retrenching back to their home markets where their local knowledge gives them a competitive advantage. Whereas with non-European investors it is clear that it is the largest markets that attracts them.’
Office, residential and industrial/logistics remain the preferred sectors for all investors targeting Europe, however below their seven-year averages. At nearly 70%, offices took the top spot which, though possibly counter-intuitive, can be partially explained by non-European – and Asian Pacific investors in particular – identifying it as the sector of choice when accessing Europe. ‘Offices occupying the top spot might come as a surprise but it reflects the size of the market and the significant price correction the sector has went through,’ Pylypchuk noted.
Residential maintains its second-place position, confirming the structural shift toward this growing institutional market which offers a high and stable income return and a strong countercyclical strategy. At 46%, industrial/logistics – last year’s top preference – slipped to third place (it held 71% of preferences in 2022). This may be no surprise as the sector is starting to see the reversal of many years of consistent outperformance, sharp yield compression and relatively high rental growth expectations. However, given the sector is underpinned by e-commerce as a megatrend, this may well be a short-term blip.
For European investors, sector preferences line up slightly differently with industrial/logistics and residential in joint first place both at 67%, followed by offices (50%). Pylypchuk: ‘In general, riskier asset classes such as development as well as more operationally intensive asset classes have reported a decline in investors’ preferences, reflecting a general flight to safety trend on the part of all investors.’