The shifting balance of commercial real estate portfolios

Traditional real-estate assets remain dominant, but they have lost ground to other niche categories

The shifting balance of commercial real estate portfolios

With the arrival of liquid alternatives, investors have even more ways to diversify their portfolios and protect themselves from financial-market risks. The less adventurous investor might prefer to stay with familiar options, which includes investment in commercial real estate — though even there, they should pay attention to changes.

“Office and retail assets have traditionally made up the bulk of portfolios,” wrote Bryan Reid, MSCI’s vice president for Global Real Estate Research, in a recent commentary. “[W]hile they still do, their dominance has diminished over recent decades, as allocations to other real estate sectors have increased.”

The pre-eminence of office and retail properties, Reid noted, is likely due to their having established markets, more transparent operating models, and proven track records. But investors have increasingly shifted their portfolio allocations to property sectors over time.

Office assets and retail assets contributed 46% and 31%, respectively, of the capital value in the MSCI Global Annual Property Index, in 2001. By the end of 2018, however, they accounted for less than two thirds of the index, with office accounting for 40% and retail for 24%. While they still comprise the two largest sectors, their share of the average portfolio has slipped.

Reid explained that over that time, the ground they lost went to other property sectors, including residential, which rose from 11% to 17% of the index; industrial, which went from 9% to 13%; and other property types, which increased from 4% to 6%.

“As data has become more available and less well-known property types have become more established, investors have increasingly looked to diversify their exposures,” he said, citing increasingly popular niche investments such as student housing, self-storage facilities, and data centres.

Technology advancements are likely a key player in the shift. The boom in e-commerce has come with greater demand for logistics space, which has helped fuel the popularity of industrials. Less traditional property subsectors, Reid added, are likely benefitting from investors’ search for yield, as well as the weight of capital allocated to real estate.

“With the average allocation to real estate having grown strongly in recent decades, limited investment opportunities in retail and office might have led to some of the new capital flowing into other sectors of the property market,” he said. “The generally higher yields on offer in these property types might also have been part of the appeal.”

While broader opportunity sets within real estate should benefit investors, Reid cautioned that operating models, return drivers, and risk factors can all diverge considerably among property types.

“Investors may therefore want to think about whether the tools and systems they have in place to monitor and manage their investments are enough to stay on top of the changing real estate landscape,” he said.


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