Future of Alternatives 2025: AUM Growth of 3.4% a Year Will Not Lift All Real Estate Segments

Investors seeking yield will turn further toward real estate assets, while funds promising higher returns will be pushed up the risk curve

Lower for longer. Almost the entire way through the post-Global Financial Crisis economic cycle, interest rate calls have been revised downwards, or expectations of higher interest rates pushed well into the future. With COVID-19, that future looks even further away, if – a big if, given the liquidity pumped into the system – inflation is kept in check.

What does this mean for real estate? Preqin’s Future of Alternatives forecast is that private real estate assets under management (AUM) will grow from $1.05tn in 2020 to $1.24tn in 2025 (Fig. 1). While lower than our CAGR forecast of 9.8% for all alternative AUM, the real estate AUM growth of 3.4% per year should be viewed in the context of a market hit by what will likely be a period of demand uncertainty for its two largest asset classes: retail and offices. 

Despite this, demand for real estate assets persists. Public and private pension funds have been consistently increasing their allocations to real estate over the past decade. Average allocations have risen from 7.0% in 2010 to 9.2% in 2019 for public funds and 6.2% to 7.1% for corporate pension funds. Family offices too have increased exposure, from 8% to 13% over the same period. Insurance companies, banks, government agencies, and foundations have been cutting back their allocations, while allocations at asset managers, endowment plans, sovereign wealth funds, superannuation schemes, and wealth managers have remained stable.

Real Estate Will Yield Results
Investors are likely to continue turning to real estate to provide yield they cannot secure from their fixed-income portfolio. Over the next few years, bond-like real estate investments may experience rising demand. These long-leased assets can benefit from strong covenants, indexed rents, and stable cash flows, making them increasingly attractive to long-term investors or those seeking inflation protection. 

Nearly half (49%) of investors surveyed for Future of Alternatives 2025 expect to increase their allocation to private real estate, with 10% planning a significant increase, a further 31% maintaining allocations, and just 12% expecting to invest less (Fig. 2).

With the yield differential to government bonds at the forefront of investors’ minds, there may be a desire to enter new markets, where yields achievable from Grade A or prime assets are higher than in more established locations. For example, office assets in Sydney and Melbourne can yield 4.5% to 4.8%, which compares with 2.6% for prime German CBD assets, but they are often at different points in their own cycle, with vacancy and incentives increasing from a low base in Sydney. If income is the main driver, geographic arbitrage could become more common.

Taking Risks to Generate Returns
Real estate allocations do not only target income. Returns can be boosted by moving up the risk curve, with development and large-scale refurbishment of assets a potentially more attractive future strategy. Owners of poorer-quality offices, or those in secondary locations away from transport hubs, may be exposed to more downside risk in future years than they have been recently. COVID-19 will have a lasting impact on demand for space, but while fewer people will be working solely in an office, more space per person will be needed when people are mixing more closely together. Offices without collaboration space or quality video conferencing suites may lose out to new developments or heavy refurbishments, where buildings have been designed with these new working practices in mind. An added benefit for occupiers in newer buildings will be increased efficiency in heating and ventilation, boosting commitments to ESG practices. 

While offices may be subject to a wide range of threats and resultant opportunities, retail assets are likely to be laggards. Increased vacancy, lower footfall, the rise in online shopping, and growing acceptance that shops may not be the driver of online activity that was previously expected, will hit the sector hard. Each of the issues listed could have a negative impact individually, but when combined they could result in major changes to the way retailers view their estate and how investors price these assets. 

It is unlikely that the real estate sector will evolve in a linear way over the next five years. We expect the gaps between the winners and losers to widen. 

Download a data pack containing all the charts in our asset class forecast articles for Future of Alternatives 2025. For more predictions and projections from Preqin on the future of the alternatives industry, visit our Future of Alternatives 2025 Content Hub.