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Family Offices Want to Play it Safe When Making Real Estate Bets

Given the current cap rate environment, clients are more inquisitive about how a fund manager assesses the value-add proposition of an asset along with its potential for greater NOI.

Family offices have seen a slight dip in real estate allocations, but new data suggests they’re still sold on the asset class as an investment target.

In a global report from UBS and Campden Research, family offices indicated they’re “rather optimistic” about the future of real estate as an asset class, “despite a somewhat weaker performance in 2016.” Forty-five percent of those surveyed planned to maintain real estate investments going forward, with 40 percent eyeing an increase in such investments.

Although direct investment in real estate by family offices declined by 0.7 percent from 2016 to 2017, the asset class remains the third largest in the average family office portfolio around the world, the UBS-Campden Research report says. In North America, the asset class represents 10 percent of family office portfolios.

In a different survey — this one by Preqin, a provider of data and intelligence for the alternative assets sector — 57 percent of fund managers said family offices’ appetite for investments in real estate had increased, with 29 percent saying the appetite was the same and 14 percent saying the appetite had decreased.

Looking ahead, the Preqin survey found that family offices are most likely to turn to real estate, equities, private equity and ETFs to boost their allocations.

The UBS-Campden Research report confirms commercial real estate is a far more popular asset class than residential. In North America, for instance, family offices demonstrated a stronger preference for investments in commercial property (62 percent) than residential property (38 percent).

However, the popularity of real estate as an asset class for family offices has been tempered by concerns over pricing and liquidity.

“The challenge for investors … is that most all asset classes are expensive these days,” says John Workman, managing director of Pathstone Federal Street, an investment advisory firm that works with family offices.

“In real estate, which many family offices access through direct investment or investment in private funds, there is not the kind of liquidity one might wish to have when you feel forced to invest in overpriced assets,” he adds. “We believe this may be one of the primary reasons behind the hesitation by many to invest in the less liquid investments today.”

That hesitation helps explain the average 7.7 percent annual investment return for North American family offices in 2016. The UBS-Campden Research report attributes that attractive gain to relatively lower allocations in real estate in favor of higher allocations in equities and private equity.

To avoid the pricing and liquidity hurdles of real estate, Workman says, some family office investors are seeking creative ways to participate in the sector, such as investing on the debt side or scoping out second- or third-tier markets where there’s less competition from big institutional investors.

“A number of our clients have made their wealth via real estate investments, and they tend to continue to invest directly into properties,” he says. “For the majority of our client base, however, investing via funds is the primary way they gain exposure to the real estate markets.”

In general, Workman views real estate as an inflation hedge and a growth asset for his family office clients. He aims for equity-like returns, at minimum, on those investments, so that typically leads to core-plus or value-add real estate opportunities in the private market.

All in all, Workman says he’s being “quite selective” about putting money into real estate on behalf of his clients.

That caution extends to real estate funds, according to Katherine Rosa, global investment specialist at J.P. Morgan Wealth Management, an asset manager whose clients include family offices. Given the current cap rate environment, clients are “increasingly wary” of funds, she says, and are more inquisitive about how a fund manager assesses the value-add proposition of an asset along with its potential for greater NOI.

“While some clients see the value of the steady return and favorable exposure to inflation and rising rates that core real estate can offer, they can often be slow to pull the trigger when they don’t see a compelling reason to invest now. They often say they want to wait for a dip,” Rosa says.

Family offices aim for 4 percent yields from core real estate, she says.

“The asset class has … recently demonstrated the ability to generate high risk-adjusted returns, aiding in distributing funds back to investors at record levels and having a positive impact on investor appetite for real estate,” says Oliver Senchal, head of real estate products at Preqin.

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