Roundtable: The Investor Perspective

Three major institutional investors in real assets join CBRE Investment Management CEO Chuck Leitner to debate the opportunity set of today

Real assets have become an integral component of most institutional investor portfolios. Dutch asset manager MN, for example, has exposure to real estate, infrastructure and to a lesser extent timber on behalf of its clients. “We have been investing in real assets since 1948, and it is a very important part of our business,” says Jeroen Reijnoudt, who is responsible for international real estate investment at the firm.

GIC, meanwhile, invests in both infrastructure and real estate. The Singaporean sovereign wealth fund’s target allocation to real estate is 11 percent, according to Adam Gallistel, who is responsible for the firm’s real estate equity and debt investment in the Americas, although its actual allocation falls somewhat short of that.

GIC likes real assets because of the inflation hedge they provide. “The appraisal lag that’s embedded in private assets has real value as well, because it provides some smoothing on actual reported earnings at the overall portfolio level,” Gallistel adds. “Real assets are expensive, certainly. But while valuations are elevated across every asset class, we believe real assets are somewhat less elevated. In a place where there is nowhere safe to run, real assets provide a modicum of protection.”

And it is not only institutional investors that have been won over by the resilience of real assets. Retail investors are also increasingly looking for exposure to the asset class. Real estate is a fundamental investment exposure of New York Life’s general account. New York Life Investment Management, the insurer’s asset management division, also partners with CBRE Investment Management to provide its retail clients with access to real estate and infrastructure strategies in public and private markets. “Clients are looking for income and capital appreciation,” says Jae Yoon, chief investment officer at NYLIM. “They also like the low correlation with other asset classes.”

“We increasingly see commonality in the goals of institutional investors and retail investors,” adds CBRE Investment Management chief executive Chuck Leitner. “Retail investors want access to institutional-type risk and reward strategies. They are looking for income and inflation protection. But they also tend to have certain liquidity needs, so most of the solutions we provide on behalf of NYLIM involve the listed markets.”

In reality, some degree of listed exposure is deemed increasingly important for institutional investors as well. “Listed real estate is unfortunately too volatile to play a dominant role in our portfolios, given the strategic aim that was given to real estate, which was stable income,” says Reijnoudt. “However, it certainly has features that can work to your advantage, too, and we try to use those features carefully. Listed real estate can, for instance, be a flexible way of entering parts of the market where you cannot find the exposure in another way.”

Gallistel adds: “We play in both the public and private markets. Public market valuations often substantially diverge from private value. At the end of the day, it is still the same underlying real estate, but sometimes value is better found in public markets and sometimes in private markets.”

A prime example of that would be the early days of covid-19, when the public markets went into freefall. “It was possible to buy some of the best real estate in the US at 50 cents on 2019 dollars,” Gallistel explains. “But you couldn’t buy anything in private markets. They were frozen.

“If you didn’t have public markets in your tool kit, you were dead in the water. That’s how we view public markets – as a place to access great real estate at deep value that is often harder to harness in the private markets in scale.”

Shifting opportunities

In addition to having the flexibility to pivot between listed and unlisted markets, investors are also recognizing the need to be fleet of foot when it comes to moving between sectors. The world is changing at breakneck speed, and allocation strategies have to be responsive.

“You always need to focus on the trends that are shaping tomorrow’s society. Research is, in that perspective, the key to unlocking successful real estate investing,” says Reijnoudt.

“Research heavily influences the way we select investments today, and in this rapidly changing era, it is more important than ever to consider the positioning of a particular fund in various ways: the research of the fund and its resulting weighting to different sectors and regions, use of leverage, development phase, cost-efficiency, sustainability and exposure to climate risks.”

Leitner agrees: “Much deeper subsector analysis is required. The days of allocating generically to industrial or multifamily or office are long gone. The approach has to be more scientific.”

This can be challenging, particularly for investors such as MN, which relies heavily on funds, alongside some separate mandates, for its real assets exposure.

“We still see a mismatch between the opportunities in real estate fund offerings and the actual needs of our clients,” Reijnoudt says. “It is astonishing that until a couple of years ago there was only one pan-European residential fund, which we cornerstoned. There are also only a handful of industrial funds. The market is very limited compared to the increasing demand.”

Industrial, of course, is an extremely sought-after sector, given both the exponential rise in e-commerce and the fundamental changes to supply chain management. But with popularity comes rising prices, so investors have to think carefully about what type of logistics assets to back.

“We are making a host of bets around the future of industrial,” says Leitner. “It’s all expensive, but underneath the surface there are some expensive assets worth paying up for.”

Yoon is unconvinced, however. “Everyone is chasing logistics, and the prices have become unreasonable,” he says. “We went from buying logistics to building logistics. At this point, building logistics is expensive, so we are pivoting to other sectors for better opportunity.”

“The fundamentals look fantastic, but increasingly industrial is being priced to perfection,” adds Gallistel. “Having said that, it is also one of the most liquid parts of the market, so from a practical perspective, if you are a large investor, you don’t really have a choice but to be active in the sector.

“If you are running a $500 million or $1 billion opportunistic fund, you can go hunting where the real alpha opportunities are, but shunning valuations in the largest and most liquid sectors in real estate is just not feasible for a large institutional investor.”

Leitner says that CBRE Investment Management has continued to have high conviction on logistics, as well as multifamily – which is also extremely competitive – partly due to the fact these sectors allow the firm to manage concentration risk better because the individual properties are typically midcap.

“We can have multi-billion [dollar] exposure diversified across a number of buildings, locations and occupiers. That is one reason why those sectors are in favor. It is not just the fundamentals, but also the risk management around those portfolios,” he explains.

“In fact, a lot of large investors favor the mid-cap market. It can be very difficult to avoid concentration risk with mega-projects such as large Manhattan office properties. I live in New York. I am bullish about New York, and I am sure these will be a tremendous success some day. But it is a very large bet.”

Meanwhile, even sectors facing challenges have potential. “While we are clear eyed on the headwinds in both retail and office, we see pockets of opportunity, relative to many institutional investors,” says Gallistel. “In the US, we have never owned many malls, so that leaves us unburdened. We are not licking the wounds of the past and can approach the sector as a potential opportunity.

“Retailers recognize that they need some sort of omnichannel distribution. At some point, investors must realize that e-commerce companies can’t be charities for the benefit of consumers in perpetuity. Eventually they have to make money, and we believe that a physical footprint will be an integral part of most profitable retailers’ businesses.

“Is that physical footprint going to look like the mall of the 1980s? Probably not. Is the US fundamentally over-retailed across strip and big box? Yes. I think it is going to be a painful winding-down process, but I do think there are areas within retail that will prove resilient.”

Office, on the other hand, is a sector that is just too big to ignore, according to Gallistel. “It is the largest investable institutional real estate class. We do not buy into the narrative that office is going the way of retail,” he says. “Office already had problems pre-covid in that it was a low cap-rate, capex-intensive sector, with a business model that’s a bit like Russian roulette when it comes to rolling leases – so I never really understood why it was considered the most core of core real estate.

“It carries cashflow volatility and operational risk. Nonetheless, we don’t believe the apocalypse is nigh. I think there are gems to be picked up, and it could be a good time to be hunting in this space.”

Yoon agrees. “Real estate is a longterm investment. It is important to have a strategic view, but it is also important to be flexible and ensure you give managers the mandate to pivot exposures,” he says. “We pivoted from buying to building logistics and that margin spread seems to be dissipating. We are now again looking at commercial and office real estate where selective opportunities are interesting.”

The power of big data

As investors grapple with sector allocation and construction risk, they are increasingly turning to big data to aid their decision making.

“We need to build better infrastructure to draw on the data that has become available in real estate,” says Yoon. “It can provide a real information advantage and is a focal point for creating outsized returns and beating benchmarks.”

Yoon points to data telling us that single-family rental is going to be an important market in America, given issues around affordability of housing, for example. “In a country like Germany, it is normal to rent, but in the US it has always been all about ownership. The data tells us that is now changing.”

“The industry needs to embrace machine learning to help forecast,” agrees Reijnoudt. “Human judgment is still necessary, of course, but investment in machine learning and data analytics is essential.”

But Leitner believes that the availability of data alone is not enough. “You need to turn data into information and then information into knowledge. Without that, its usefulness is limited,” he says. “As an industry, we have to figure out how to ensure that that knowledge is on the dashboard of every decision maker, so that it is really making a difference to how we invest. It is about making it an actionable resource. The industry needs to learn how to use data to gain a first-mover advantage. There is a lot of data out there, but we are still in the early stages when it comes to making it useful.”

Gallistel, meanwhile, is skeptical on the role of big data in real assets. “Everyone talks a big game about how they plan to harness data, but when it gets down to the brass tacks of even taking their own internal data and getting it into a clean, digestible format, it tends to be a case of two steps forward and one step back,” he says.

“Right now, the promise of big data is just that – a promise. Even those with fairly robust data analytics find that a lot of the outputs are the same as the answers you were getting before the multi-million-dollar investment.

“Our Holy Grail is to use data to produce counter-intuitive insights to lead us to a market that was not on our radar or to take us out of a market that everyone else thinks is hot. But we have yet to see anyone producing insights like that in any meaningful fashion. By and large, big data is confirming the existing wisdom of the crowd.”

Leitner, however, believes it is too soon to confidently predict how the vast secular trends that are revolutionizing sectors such as retail and office will play out. “It is a difficult time to be a contrarian. It feels early in terms of what those occupier trends are going to be,” he says.

“You would need to be brave to go in now, which is part of the reason that we feel good about safer sectors, even though they are expensive. Some of what is going on in these out-of-favor sectors is more than just opportunistic pricing. In fact, we are not even seeing opportunistic pricing. Office buildings are still selling at amazing prices.

“As much as we like to be contrarians, we need to be careful before determining the best way to redefine our weighting to very uncertain sectors like office and retail. There are a lot of things going on beneath the surface. It’s not just a question of supply and demand being out of whack. There is a whole new paradigm around what people want from an office experience, and it is still early days in terms of knowing what that is.”

An alternative approach

There is always the option to explore so-called niche sectors. GIC has been investing in alternative sectors for more than a decade.

“If I look back at what led us into the niche sectors, it was our knowledge of the public markets, where these sectors were already well represented, coupled with concerns about valuations and/or fundamentals in the traditional institutional asset classes,” says Gallistel. “We saw these alternative sectors where there was readily available information, trading at higher yields, with financing cost and availability as good as or better than traditional real estate, with lower capital intensity, leading to better free cashflow conversion.

“By definition, that means more dividends to put in your pocket. I always think dividends are the best hedge against inevitable mark to market. Fast-forward to today and all of that is still true, with the exception of the higher yields. Alternatives still represent a good bet relative to ODCE. It’s just not the same no-brainer it was a few years ago.”

In addition to making considered decisions around sector exposure in light of transformational shifts in the way we live, work and shop, investors are also having to revisit decisions around buy versus build.

“Development used to be a four-letter word for me in the US because I didn’t think we were well paid for taking development risk; particularly in the US, where it is hard to argue we are undersupplied in anything,” says Gallistel. “But there is a place in our portfolio for development because, as it turns out, people like new buildings, and if we can deliver new buildings that aren’t at the top of the market, that’s quite compelling as they can capture more than their fair share of demand.” One area many investors are taking development risk in is life sciences, because there is limited stock, and that stock is controlled by a handful of key players.

It can also be possible to build industrial and multifamily assets at similar or lower prices than they are trading at. Crucially, logistics sheds and low-rise buildings can be built in less than two years, so the construction and economic cycle risk is limited when compared with a high-rise office building.

Finally, hyperscale data centers are also trading at substantial premiums to replacement cost. There are barriers to entry in that market, however, because there are really only four major tenants, Facebook, Microsoft, Amazon and Google, making it challenging if an investor is not aligned with an incumbent.

The real estate departments at Microsoft or Amazon tend to be less sensitive to the last marginal dollar and more sensitive to the leverage they gain from having an extensive global relationship with the data center provider.