Private real estate has become one of the most widely utilized alternative asset classes due to its strong performance in the past few years. As shown in Preqin’s H1 2017 Investor Outlook, 42% of investors interviewed by Preqin stated that their private real estate portfolios had exceeded expectations over a three-year period – the largest proportion of all alternative asset classes.
Positive returns have contributed to the growth of real estate assets under management (AUM) for seven consecutive years, although there was a small decline from December 2015 to June 2016, which could be attributed to the record levels of distributions made to investors in 2015 ($212bn).
The positive sentiment surrounding the asset class led to strong investor appetite, attracting fund managers to raise new funds, and has resulted in a record number of funds in market. A highly competitive market coupled with high levels of dry powder have ultimately led to an increase in real estate asset valuations. These issues perhaps make it increasingly difficult to source the lucrative deals that will maintain the high returns seen in previous years; 53% of investors and 59% of fund managers surveyed are finding it harder to find attractive opportunities.
However, these concerns do not appear to be deterring LPs or GPs from the asset class. Investor appetite over the short and long term remains positive: a greater proportion of investors surveyed plan to commit more capital in 2017 than in 2016 (25% vs. 18%), and 90% of investors plan to maintain or increase their allocations to real estate in the longer term. Furthermore, two-thirds of fund managers surveyed plan to deploy more capital in 2017 than they did the previous year. However, a large portion (42%) of managers surveyed are finding the need to adjust their strategies as a result of the recent competition and valuations. Some firms have been seeking investments in different markets, or sought investments in riskier strategies in order to generate higher returns.
Investors have likewise adapted to these conditions by placing their faith in the deal-sourcing capabilities of the largest managers as well as the potential for higher returns of the smaller firms. Sixty percent of managers with less than $1bn in AUM and managers with $5bn or more in AUM witnessed an increase in investor appetite, compared with 35% of mid-sized players that reported an increase in demand from investors. Mid-sized managers will have to work harder to raise capital in a crowded space by positioning themselves distinctively in the market.
The private real estate market has proven to be a top performing asset class for institutional investors in recent years. So much so that it may become a victim of its own success, with large amounts of capital chasing fewer viable assets and pushing valuations to a point that may affect the eventual performance of vehicles. These added challenges, however, have not affected the sentiment of investors or real estate fund managers; capital should continue to flow into the asset class, although GPs may find fundraising a challenge and may have to adjust their investment strategies in order to secure capital.