Institutional investors, faced with a less enticing equities market and low yields on fixed income investments, are seeking to increase their portfolio weightings in high-return alternative investments, and many are looking to real estate as an increasingly attractive option, according to Macfarlan Real Estate Investment Management.
“Institutional investors are putting money into all sorts of hard assets today, including oil and gas, timber and boxcars,” said Dean Macfarlan, CEO of Macfarlan Real Estate Investment Management. “But of all the hard assets, real estate offers some of the best opportunities.”
Institutional real estate sales to hedge funds, overseas investors, private equity funds, partnerships, pension funds, endowments and the like, surged 50 percent in 2004 to $180 billion, according to PNC Real Estate Finance, part of the PNC Financial Services Group. Meanwhile, PNC reported, real estate prices soared to an all-time high in many parts of the country as record levels of cash poured in.
Macfarlan said that the current real estate environment should influence how institutions allocate their alternative investments. These days, opportunistic real estate is more appealing on a risk-adjusted basis than core properties, like high-priced industrial space, unfilled trophy office towers and overbuilt apartments. Increased demand for such properties is driving prices up and cap rates down.
Macfarlan noted that institutional portfolios typically contain 5-15 percent allocations in alternative investments. He said institutional investors looking at opportunistic real estate investments seek three qualities in choosing investments: Recovering sectors, high-risk adjusted returns and a trustworthy real estate sponsor with a track record of success. Macfarlan said institutional investors should look for and invest with real estate sponsors with their own money invested in a recommended fund.
A strong niche for 2005, and one that should appeal to institutional investors, is the hospitality sector, particularly luxury hospitality developments. Hotel profits in the United States increased by about 13 percent in 2004, and are projected to increase by another 14 percent in 2005, according to the 2005 P&L Forecast published by PKF Hospitality Research.
Opportunistic investments in hospitality developments have a target return of 18-22 percent, providing ample returns for alternative investment allocations. Macfarlan said the resort and Private Residence Club (PRC) market is ripe for investment. PRCs are exclusive vacation homes designed to provide five-star accommodations in premier ski, golf and ocean-side locations. Ownership of PRC properties is shared among the wealthiest consumers, seeking first-class amenities such as private-beaches, full-service spas, cooks and full domestic staffs. As the number of wealthy wage earners becomes younger and 77 million Baby Boomers prepare to inherit $13 trillion in the coming years, the market for second homes and vacation properties is poised for steady growth.
Meanwhile, wealthy consumers are showing an affinity for “fractional ownership” of luxury goods, such as yachts, jets and homes. Wealthy consumers who desire luxurious second homes are opting to own a partial interest and avoid the maintenance expenses and leasing headaches associated with full ownership. All of this, Macfarlan says, creates strong demand for PRC properties.
“There is the promise of huge growth within the PRC niche,” Macfarlan said. “We predict that vacation homes will be one of the fastest growing real estate sectors over the next decade, and provide portfolio managers with the balance and growth they need.