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Sovereign investment in real estate picks up pace

Sovereign wealth funds, state pension funds and central banks are increasing their allocations to real estate, driven by attractive returns and an abundant supply of investment opportunities, a report by Invesco found.

The Invesco Global Sovereign Asset Management Study 2017, based predominantly on face-to-face interviews with 97 sovereign investors, found that the generation of higher yields was the primary factor driving investment in real estate for 58% of those surveyed. Sovereign investors are beginning to view real estate as a reliable source of income in a prolonged environment of low fixed-income yields, the report said. "Accessing liquidity premium" was identified as the driving force for 18% of respondents, while "diversification from traditional assets," at 15%, and "long-term investment," at 9%, were also factors.

Sovereigns cited real estate as the asset class with the "fewest execution challenges" due to "broad access to commercial and office sectors across major developed and emerging markets," the report said. Only 27% of sovereign investors in 2017 were underweight to real estate due to execution challenges, down from 45% in 2016. By comparison, those in the underweight camp for private equity fell from 60% last year to 54% in 2017, while infrastructure saw a rise to 71% from 70%.

Sovereign investors with large internal teams pointed toward the scope for greenfield investment as a key differentiating element of real estate as an asset class. "Sovereigns continue to develop internal asset management capability in real estate, enabling them to generate investment opportunities themselves, rather than source and compete for real estate deals with other investors," the report said.

Real estate makes up 50% of assets under management by those sovereign investors operating internal teams to manage international illiquid alternatives, while private equity accounts for 22% and infrastructure comprises 15%, according to the report.

Though real estate still accounts for a small proportion of sovereign portfolios, significant relative growth in real estate allocations, particularly in sovereign home markets, was reported by investors. Home market real estate as a percentage of total AUM rose from 2.2% in 2016 to 3.4% in 2017, up from 1.2% in 2015. This compares with international real estate as a percentage of total AUM rising to 4.7% in 2017, compared to 2.8% in 2015 and 4.4% in 2016.

"Home market real estate is attractive for liability and investment sovereigns, as there is no need to hedge currency exposure," the report said. "Home market allocations also benefited from the trend of internalization of real asset management. With limited capability to source and manage real estate globally, sovereigns noted that internal investment teams focused more on the local market, particularly in respect of greenfield or residential investments."

Real estate compares favorably to other options in terms of its potential for sovereigns to take an active role in the investment. "While there are few alternatives to third-party management and fee structures across infrastructure and private equity (with co-investment in many cases challenged by fund governance and risk appetite), sovereigns have a broad range of options to participate in the development, acquisition and management of real estate," the report noted.