In 2011, real estate industry assets under management surpassed $500bn for the first time, and reached a post-crisis fundraising record in 2015. As at the end of 2017, total assets stand at $0.8tn and real estate is the third largest asset class in alternatives, behind hedge funds and private equity. The story of real estate thus far is one of growth in post-crisis recovery, with large-scale distributions back to investors – but for how long can this growth story continue?
Preqin research conducted at the end of 2017 revealed that many industry participants feel we have reached the peak of the real estate cycle. The rate of deal flow has slowed in 2018 thus far, and rising dry powder levels are intensifying competition for limited opportunities, pushing up pricing. However, inflated pricing leads to rising distributions and a healthy exit environment. The outlook for the asset class is positive, as recent performance is encouraging and investor interest is rising across the full spectrum of real estate strategies. The uptake in interest in strategies such as debt, which is generally counter cyclical, and distressed, which typically has a lower risk/return proposition, could well herald a change in market conditions on the horizon.
In June 2018, Preqin conducted a large-scale study with fund managers and investors across alternatives, as well as using our own proprietary data, to gauge what the future may look like for the industry. Driven primarily by steep growth in the younger asset classes of natural resources, private debt and infrastructure, Preqin expects the alternatives industry to grow to $14tn in total assets by 2023. As a more established industry, growth in real estate is expected to be comparatively slower, at a rate of 50%. If our predictions are correct, then the private debt market would overtake real estate to become the third largest alternative asset class.
Given the strong appetite for alternatives, most managers (80%) surveyed across alternatives are anticipating organic growth to contribute significantly to their expansion over the next five years. Among real estate managers, 30% expect that joint ventures with other managers will help them expand their offerings by 2023, perhaps to gain access to bigger deals.
Among alternatives investors surveyed, 77% believe the number of fund manager relationships in their alternative programs will increase over the next five years. In terms of investor allocations to each asset class, 54% of investors surveyed expect to increase their allocations to real estate over the next five years. While such growth is not as high as for some asset classes (vs. 70% of infrastructure investors and 79% for private equity), it compares favourably to others (35% for venture capital and 17% for natural resources), and the proportion (15%) of investors projecting a decrease in allocations is not a sizeable one.
As environmental, social and governance (ESG) considerations gather momentum in the alternatives space, fund managers may be faced with increasing ethical demands from investors. Alignment of interests in this area may therefore be more important than ever, particularly if the level of investment in emerging markets continues to grow, as our survey results would suggest. Within real estate, similar proportions of investors (73%) and fund managers (75%) believe that ESG will become more important to alternatives over the next five years.
Against a backdrop of potentially wide-sweeping developments in financial technology – such as AI/machine learning and big data processes – starting to ripple through the alternatives industry, there could well be changes on the horizon for the real estate industry. Among all managers surveyed, significant proportions believe advancements in technology could benefit their operations in the next five years, particularly in the areas of research (65%), fund operations (62%) and trade execution (56%). Most fund managers and investors across alternatives are in agreement that such technologies will be more relevant to alternatives in 2023.
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