(Sept 9): Anyone who has played the computer game SimCity will be familiar with the challenge of having to find the right balance of residential, commercial and industrial zones to develop their virtual city. In the real world, investors in commercial real estate face a similar dilemma when deciding the appropriate mix of property types for their portfolios. Office and retail assets have traditionally made up the bulk of portfolios. While they still do, their dominance has diminished over recent decades, as allocations to other real estate sectors have increased. The shift in the composition represents an evolution of the asset class and highlights how technology and the search for yield have led investors to diversify and seek exposure to other property types.
Established markets previously set the tone
The preeminence of office and retail properties can probably be attributed to established markets, more transparent operating models and their proven track records. But, over time, their dominance has waned, as investors have increasingly shifted their portfolio allocations to other property sectors. In 2001, office assets accounted for 46% of the capital value in the MSCI Global Annual Property Index, and retail assets accounted for 31%. Together, these two sectors made up more than three-quarters of the total index. As at end-2018, however, they accounted for less than two-thirds of the index, with office falling below 40% and retail’s weight down to 24%. They are still the two largest sectors in the index, but their share of the average portfolio has diminished.
As the weights of office and retail have declined, allocations to other property sectors have increased. Between 2001 and 2018, residential has risen to 17% from 11% of the index, industrial has increased to 13% from 9% and other property types have increased to 6% from 4%.
These trends are no accident
Real estate has matured rapidly as an asset class; and as part of its evolution, its sector profile has evolved. As data has become more available and less well-known property types have become more established, investors have increasingly looked to diversify their exposures and gain access to the different risk-and-return profiles these sectors could offer. Student housing, childcare centres, self-storage, healthcare facilities, data centres and hotels are examples of the more niche investments that have increased in popularity.
Technology advancements are probably playing an important role in driving this shift and helping create new opportunities. For instance, as e-commerce demand has boomed, so has the need for logistics space; and this has undoubtedly helped fuel the popularity of the industrials sector. The search for yield and the weight of capital allocated to real estate are probably other important factors helping drive demand for investments in the less traditional property subsectors. 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. The generally higher yields on offer in these property types might also have been part of the appeal.
Caveat emptor
Overall, the broadening of the opportunity set within the real estate asset class should be beneficial to investors, as it allows more flexibility and greater potential diversification in real estate exposures. With this greater flexibility comes added potential complication, however, because operating models, return drivers and risk factors can all vary considerably from property type to property type. This can be especially true in more niche sectors. 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.
The changing face of real estate portfolios
• Office and retail investments still account for the bulk of typical commercial real estate portfolios, but have become less dominant;
• Investments in other property types — including logistics centres, student housing, childcare centres, self-storage, healthcare facilities, data centres and hotels — have increased in popularity; and
• The broadening of the asset class should help investors tailor and diversify their real estate exposures, but may also increase the complexity of managing the real estate allocation.
Bryan Reid is vice-president of Global Real Estate Solutions Research at MSCI
