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Institutional Investors Work Harder to Boost CRE Returns

Institutional investors are searching for ways to maximize yield both in new acquisitions and within existing portfolios.

Institutional investors looking to outperform industry benchmarks are bracing for bigger challenges ahead due to rising interest rates, fewer transactions and a lower trajectory for appreciation and NOI growth.

Institutional investors remain disciplined in their investment strategies. At the same time, many are searching for ways to maximize yield both in new acquisitions and within existing portfolios.

“What is occurring now more so than in the past is that every institutional investor is looking for outperformance,” says Brian McAuliffe, president, institutional properties, at CBRE Capital Markets.

With projected total unlevered returns on NCREIF at 6 percent—or potentially sub-6 percent—in 2018, the current yield in the existing portfolio becomes very important, notes McAuliffe.

“That’s why you start having more recycling of assets that may be underperforming or are expected to underperform the benchmark. So the goal is to sell some of those assets and try to find those opportunities that are going to outperform,” he adds.

In its 2018 Emerging Trends in Real Estate Report, PwC noted that some institutional investors may be “fully invested” in real estate equity. Although that does not mean that institutions are moving to the sidelines, it does suggest that they could be more focused on “moving pieces on the chessboard” in order to improve strategic positioning within portfolios. “I don’t think there is anything unusual happening. It is indicative of where we are at in the cycle,” says Byron Carlock, real estate leader for PwC.

Plenty of dry powder available

Two of the biggest headwinds facing investors this year will be rising interest rates and tepid rent growth. Both of those challenges could create some uncertainty. “We certainly hope and expect that the amount of capital that is available, not only institutional, but private domestic and global, will offset any type of headwinds that may impact values,” says McAuliffe.

Institutions continue to have a desire to acquire real estate. Yet they are adapting to the maturing cycle. The double-digit appreciation that properties were producing in 2014 and 2015 resulted in rising values related to assets under management. Now what’s happened is that the appreciation factor has subsided significantly. “So the rate of growth within asset management firms is much more dependent on acquisition activity, because appreciation is not as robust as it was in the past,” says McAuliffe.

Institutions also have capital available from new inflows and/or proceeds that are coming in from the disposition of assets. Some institutions are doing some pruning, culling and repositioning of portfolios, as well as taking advantage of appreciation and current pricing for “old-fashioned profit taking,” notes Carlock. “I’m seeing that asset managers have no problem pulling the sale trigger and there is still plenty of capital to buy good assets,” he adds.

For example, PGIM Real Estate recently announced that it had completed $4 billion in U.S. acquisitions in 2017. About two-thirds of its acquisitions were in the multifamily sector, while the company was a net seller of office assets with more than $2 billion in dispositions. PGIM Real Estate is one of the investment management businesses of Prudential Financial Inc.

According to London-based research firm Preqin, 265 funds raised $111 billion in capital commitments in 2017, which is down 12 percent compared to 2016. North America-focused funds accounted for 62 percent ($70 billion of the capital raised). In addition, Preqin is also reporting that as of December 2017, global private equity real estate funds had $249 billion in dry powder available to invest.

Stability vs yield

Yields are a big priority for all investors. However, PwC expects yields to be a bigger topic of discussion among pension funds moving forward. Pension funds are evaluating the amount of yield that will be required—versus realistically achieved—as it relates to supporting pension liabilities for baby boomers.

In most cases, institutions are working on a variety of strategies to deliver a higher overall blended return. “With yields where they are right now, I see a lot of velocity in the core and core-plus space to get assets in those long-term hold, NCREIF-denominated funds. And then I am seeing a lot of activity in the value-add space to create yield,” notes Carlock. For example, investors are more focused on redeveloping and repurposing assets to create higher yields than what they can find in buying stabilized assets, he adds.

Many institutions have made industrial logistics a very high priority. However, the lack of opportunities makes it very challenging for investors to achieve the target allocation for industrial. In addition, more capital is flowing into debt financing, infrastructure and non-traditional real estate sectors as returns on traditional core assets move lower. “I think well-spent infrastructure could be the next big boom for our industry, and that is a trend that people are discussing,” adds Carlock.

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