Most people think real estate is a safe bet, but 1 key indicator looks like we're in for another Great Recession
- Big Wall Street investors are now investing roughly 10% of their portfolios into real estate and increasingly, they're putting their money into higher-risk, higher-return properties.
- Joe Azelby, head of real estate and private markets at UBS Asset Management, said he's concerned about this trend especially among US pension funds.
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Big Wall Street investors are now investing roughly 10% of their portfolios, or $1 trillion, into real estate and increasingly, they're putting their money into higher-risk, higher-return properties. This trend reminds at least one expert of the years before the Great Recession.
Joe Azelby, head of real estate and private markets at UBS Asset Management, had a mostly positive view of the real estate market when he spoke at UBS's Panorama Roundtable event last Thursday.
However, Azelby pointed to a "worrisome" trend: the increasing amount of higher-risk real estate in investors portfolios, especially among US pension funds. This type of real estate, known as value-added, requires renovation or development, but also can lead to much higher returns on investment when sold or rented.
Investors have traditionally invested the vast majority of their real estate portfolio into core assets, instead of value-added. Core assets are the safest and most-guaranteed real estate assets, providing income through sources like rent. With interest rates close to core assets' usual rate of return, and real-estate prices high, core assets are unable to provide yields at the level that investors want.
US investors are now investing record levels of their portfolios into value-add real estate. According to a 2019 study conducted by Kingsley Associates for Institutional Real Estate Inc, large investors invested 22.5% of their real-estate portfolio into value-add properties. They also invested a record-high of 9.5% of their portfolios into foreign real estate, which can be as risky as value-add properties.
"The thought is I'm going to move out the risk curve to either develop, redevelop or do higher-risk, higher-reward activities in order to get a higher return," Azelby said. US pension funds in particular are especially attracted to these risky investments because they are trillions short in funding and need higher returns to make up their shortfall.
Azelby explained that this strategy is reasonable until the economy is hit with a downturn.
"People did a lot of this in 2006 and 2007, and it didn't end very well when you got to 2008 and 2009, because buildings that were half-built and buildings that were half-leased performed very poorly," Azelby said.
Value-add real estate is often illiquid, as it requires significant investment to make a profit, compared to core assets which provide liquidity through rent and other income. In a downturn, pension funds could run out of liquid cash if they invest too much into value-add real estate.
Read more: The US pension system has gotten so bad that Congress is planning for its failure
The Dallas Police and Fire Pension System almost went bankrupt in 2016 when too many of its assets were tied up in real estate, especially value-add, and members began to withdraw their money as the fund began to underperform. It was rescued through state legislation, is an example of what could happen on a larger scale if money continues to flow into value-add real estate.
Azelby was also cautious about causing concern, and doesn't think this means we're heading for another crash. Under today's conditions, he wouldn't call this strategy irrational.
"It actually could be a reasonably smart move to continue to do what's worked for the last seven or eight years, but only time will tell," Azelby said.