New return drivers and investment processes

Institutional investor’s portfolios often include real estate assets with target allocations from nine to ten percent. Between 2011 and 2015, that allocation has actually increased from 6.7 to 8.5 percent but is thus still below investor's expectations. While investors perceive the asset class as yielding high returns, to be a tool for diversification and a hedge against inflation, barriers hinder them to invest. First, they believe real estate to be a high-risk investment, especially in developing countries. However, market characteristics such as a lack of transparency and liquidity, as well as underdeveloped capital markets illustrate a sharp contrast to investor’s equity investment strategies, says McKinsey in “Understanding real estate as an investment class”.

Due to that lack of transparency, because transactions are private and information is scarce, evaluating real estate returns is difficult. However, analysing over 10,000 investments, McKinsey finds that property returns are inversely correlated with those of conventional asset classes and thereby serve as an excellent measure to diversify a portfolio. Thereby, the growth of the real estate market is mainly due to construction activities in emerging economies to urbanise those countries, which makes more real estate asset available to investors. To retain current allocations and returns, investors may thus need to invest in developing real estates markets too.

Pursuing these investment activities, institutional real estate investors are characterised by two trends: First, they increasingly invest in non-traditional asset classes such as student housing, data centres, healthcare offices, medical facilities, and assisted-living communities. With increasing volume and transaction numbers, those assets are reaching investment grade. Second, due to higher costs and a perceived lack of control, institutional investors are building small in-house teams to develop direct-investment capabilities. Those capabilities may include improving the operation of assets or acquiring an operating platform to source deals from.

With a growth shift towards emerging markets and new business models in the range of non-traditional real estate assets, investors are searching for new ways to obtain returns. However, traditional investments in real estate investments remain very much alive.