The Real Estate Reel: We’re watching institutional allocations, CRE debt and property price disconnects

 
Rich Hill

Rich Hill

Head of Real Estate Strategy & Research

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4 minute read

October 2023

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Institutional investors have increased their allocations to real estate, CRE debt delinquency rates are increasing but remain relatively low, and CRE valuations are down more than 16% so far this year. Watch this month’s Real Estate Reel to find out what these data points mean for real estate investing.

KEY TAKEAWAYS

  • Institutional investors increased their allocations to real estate in the first half of 2023, and we see a backdrop where large investors are buying real estate to meet their allocation targets as positive for real estate prices.
  • Commercial Real Estate (CRE) debt delinquency rates are on the rise but remain relatively low, indicating the headwinds facing CRE debt markets are lower than feared in March.
  • CRE valuations are down -16.4% year to date as of August, but there are wide variations in how much levered returns are down by sector.

Transcript

  1. Institutional allocations to real estate
  2. Commercial real estate debt delinquency rates
  3. CRE property price disconnects

That’s what I am watching this month.

Welcome to 2nd edition of The Real Estate Reel from Cohen & Steers for October.

First, institutional investors increased their allocations to real estate in the first half of 2023, with an average increased allocation of 76 basis points. That’s based on data from PERE.

Sovereign wealth funds increased their allocations to real estate for the first time in four years. Public pension allocations are 100 basis points higher than they were one year ago and are now the highest allocations at 10.6 percent.

We see a backdrop where large investors continue buying real estate to meet their allocation targets. This is a positive for real estate prices in aggregate.

As you can see in this chart, almost 40 percent of institutional investors remain under allocated to real estate, while 36 percent were overallocated and 26 percent were at target. This time last year, the discussion focused on the fact that investors were overallocated to real estate.

The second data point I’m watching: Commercial Real Estate debt delinquency rates.

Three out of four lenders saw a quarter-over-quarter rise in delinquencies in 2Q 2023, according to the Mortgage Bankers Association. However, absolute delinquencies remain relatively low. That may surprise people.

Diving deeper into the commercial mortgage-backed securities market, also known as CMBS, an average of 77% of the loans set to mature each month over the last 12 months actually were paid off at or before their maturity date.

This underscores our view that the entirety of the commercial mortgage market may be under levered. We expect higher delinquencies as distress is building, but we believe the headwinds facing the CRE debt markets will be a slow burn over a longer period rather than the collapse that was feared in March.

The listed markets may be sending a similar signal as commercial mortgage REITs are the third best performing listed REIT subsector year-to-date with returns of approximately 7%(1) as of the end of September.

Finally, we are watching divergent paths in CRE prices across property types and leverage.

Green Street estimates CRE valuations are down -16.4% year to date as of August. The NCREIF ODCE index shows a decline of -10.4% as of 2Q23. We’ve previously stated that we expect the cumulative peak-to-trough correction 25% over the next year-to-year and a half.

Two points underlying this data are even more interesting. First, the NCREIF leveraged return index shows total returns are down -14.2% given loan-to-values of almost 45%. This illustrates the impact leverage can have on valuations.

Second, there are wide variations in how much levered returns are down by sector. On one end, as we can see in this chart, shopping centers are down -3.6 %. On the other end, office has dropped -28.1%. Apartments are in the middle, having dropped -13.4%.

The outperformance of shopping centers is worth monitoring given many institutional investors are under allocated to this property type. Our private real estate team is especially intrigued by the opportunities they are starting to see in grocery-anchored or necessity driven shopping, especially in the Sunbelt.

Overall, we see continued pressure for private CRE markets as the market adjusts to the old normal of higher rates and higher inflation. Some sectors are better positioned than others.

One final point: while listed REITs have faced headwinds over the past two months in-line with historical seasonality that’s exacerbated by macro uncertainty, we maintain that this offers an attractive entry point.

Subscribe to the Real Estate Reel via the link on screen and tune in next month to see what we’re watching next.


Watch September’s The Real Estate Reel: Three data points actually driving real estate investing today

ABOUT THE AUTHORS
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Rich Hill, Senior Vice President, is Head of Real Estate Strategy & Research, responsible for identifying allocation opportunities in both listed and private real estate and related thematic and strategic research.

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