Along Came Covid
By Alexander Sadighi and Kelly Keith
Known knowns and known unknowns are dominating our industry discourse. We know what we know, and there’s an overwhelming consensus on what we don’t.
During Q1 2021, Hodes Weill hosted virtual roundtable events around the world to discuss the findings from our 2020 Allocations Monitor. In conjunction with these events, we gathered additional insights from some of the most sophisticated and forward-thinking investors around the globe. The goal was to gauge investor sentiment at that moment in the constantly evolving landscape and contrast it with the findings of the Allocations Monitor itself, a survey of 200+ institutions with nearly $13 trillion in assets conducted during the summer of 2020.
We would like to express our gratitude to the participants in these surveys. Their engagement continues to contribute to a more accurate and timely understanding of global capital flows and trends in the real estate investment management industry.
Pacing: As target allocations to real estate continue to rise globally, nearly 75% of 2021 respondents are keeping pacing consistent with prior years or increasing pacing to stay at allocation. Increased pacing is generally intended to make up for under-investment in 2020 and/or capitalize on an expected strong vintage. This confirms the expectations expressed in the midst of the COVID pandemic that despite market uncertainty, institutions remain committed to the asset class and expect to be to actively allocating to new investments over the next 12–24 months.
Sentiment: Though a surprise to many, investor sentiment increased for the third straight year in 2020, reaching a seven-year high. Eighty percent of 2021 respondents are optimistic about the performance of current portfolios over the next three to five years. As one participant highlighted, this positioning contrasts starkly with prior dislocations: “the appetite for institutions to jump back into the market…was the biggest surprise. After the global financial crisis, institutions were not very active and put pencils down for a couple of years.”
Alternative Asset Classes: Appetite for non-traditional and high-return strategies has not subsided and continues to grow. Demographics and the resilience of the “new economy” continue to drive investor interest and momentum (e.g., data centers, cold storage, life sciences, studio/media assets).
Distress: Some institutions quickly shifted to distress and were able to capitalize on dramatically lower public market valuations in REITs and securitized debt. This window closed quickly though and only the nimble were able to act successfully. Although the dislocation was evident and actionable in public markets, a common theme among 2021 respondents was the surprise that private market valuations continued to remain higher than expected, particularly considering the distress in the “real” economy.
Known Knowns and Known Unknowns
These results were not surprising to us. Most of the key findings were consistent with the 2020 Allocations Monitor (i.e., surveying closer to the nadir of the pandemic did not substantially change the results) as well as the current industry discourse.
What did surprise us, however, is the fervor and certitude surrounding the “known knowns” and the “known unknowns”—there is tremendous (and uncharacteristic) clarity and agreement surrounding these themes. We do not recall a prior instance of such unified sentiment among market participants.
First Place: Industrial / Logistics. We know this asset class continues to remain the most in-demand. Although some investors are starting to question how long the music will last, there are few signs that tenant demand is waning or that investors are positioning for a correction. The careful eye is focused on how low yields can go.
Second Place: Multifamily and non-traditional asset classes. Constantly improving data collection and usage are providing increased insight into demographic and macro trends that specialized operators can exploit. Just within the last two years, 90% of the world’s data has been created. With this increase, managers have gone from using their “gut feelings” and industry insight to statistically proving trends and outlook. Moreover, this data provides investors the confidence to consider more targeted, nascent, and operationally-focused strategies. With respect to multifamily, investor appetite remains strong. The investor community is in general agreement that, in the right locations, the asset class benefits from strong demographic and secular tailwinds—population growth coupled with well-documented housing shortages, and delayed household formation with Millennials and Gen Z in transition, are compelling trends. Investors are eyeing opportunities in changing demand patterns, focusing on lower cost cities and suburbs in the Sun Belt. With respect to non-traditional asset classes, operationally intensive businesses run by skilled operators are increasingly viewed as potential sources of needed alpha. Though we received feedback that some of the more niche asset classes are starting to feel crowded, investors continue to seek differentiated approaches with these strategies.
Office: There is no question we know what we do not know. For our 2021 respondents, office was unambiguously the largest question mark, both in respect of current portfolios and investment opportunities. Compelling arguments exist for every possible outcome, but investors are waiting for the dust to settle on the unknown.
Distress: We know there should be some, but where is it? Distress was top-of-mind for our 2021 respondents, not only in positioning themselves to take advantage of it, but also in disbelief that it had not yet materialized. Anecdotally, respondents mentioned that lenders are generally being extremely accommodating and not wanting to take over and manage otherwise distressed assets. With over $10 trillion of government intervention globally, we may be waiting to find out if and when it materializes, at least for asset classes not already in or approaching distress pre-pandemic (e.g., retail).
Inflation: The specter of inflation is beginning to emerge once again in conversations. To put it plainly, we know that we do not know the impacts of $5.3 trillion of stimulus. This is a question that all of us may eventually have to tackle, but it is a currently a lower priority concern. Given inflation generally benefits shorter lease terms, which are already a focus (e.g., multifamily), investor behavior is not expected to shift radically as a result. Further, with healthy cap rate spreads against 10-year Treasury yields, investors are less concerned about rising cap rates in a rising interest rate environment. For many, inflation is simply a term learned in Econ 101 and nothing else. But, if the theories we were taught are correct, real estate should stand ready to prove itself as an inflation-resilient asset class. And for our 2021 respondents expressing frustration having to compete with their PE/VC colleagues for allocations, inflation may prove helpful for the asset class.
Honorable Mention, Hospitality: At the time of the 2021 survey (pre-widespread vaccination), respondents described hospitality as a “when” not “if” scenario. The unknown “when” appears to be closer with each passing day. Several investors commented that hospitality will certainly be a winner coming out of the pandemic, but, interestingly (and perhaps tellingly), such investors also mentioned they would be watching from the sidelines.
We are certainly blind to the unknown unknowns. But with significant uncertainty and ambiguity permeating nearly every facet of life, we should take comfort in our industry’s widespread agreement on these handful of important questions and act on them while we can.
1. Tech Jury, “How Much Data is Created Every Day in 2020?” March 18, 2021: https://techjury.net/blog/how-much-data-is-created-every-day/#gref 2. U.S. Census Bureau and National Association of Realtors, June 30, 2020 3. PERE, “Ongoing COVID-19 Crisis Has Increased Appetite for Distress” January 28, 2021: https://www.perenews.com/ ongoing-covid-19-crisis-has-increased-appetite-for-distress/ 4. McKinsey & Company, “The $10 trillion rescue: How governments can deliver impact” June 5, 2020: https://www.mckinsey.com/industries/public-and-social-sector/our-insights/the-10-trillion-dollar-rescue-how-governments-can-deliver-impact 5. Peter G. Peterson Foundation, March 15, 2021: https://www.pgpf.org/blog/2021/03/heres-everything-congress-has-done-to-respond-to-the-coronavirus-so-far