Institutions, from endowments to pension funds, have good reason to be reassessing their exposure to real estate after a decade of strong returns. Perceived headwinds, including rising interest rates and steep property values, are reducing the appeal of illiquid direct investments and private funds with tight lockups. There is also a growing disconnect between private market and publicly listed real estate investment trusts that are trading well below their net asset value.
While it is still unclear whether these factors reflect a stalled market rather than one that has peaked, we can all agree the final innings of this real estate cycle are upon us. This is the proper point for institutional investors to consider whether to alter or reduce their allocations to the asset class.
As investment teams tackle this dilemma, one solution may exist in an often-overlooked alternative: hedge fund strategies focused on public real estate. Funds investing in publicly traded real estate securities are typically built to capitalize on market dislocations, offer directional flexibility and provide insulation from asset bubbles. In turn, they can be a distinct source of alpha generation and diversification late in a cycle.
This has been the case over the past 12 months based on the HFRX RV: Real Estate index's outperformance of the MSCI US REIT index. Unlike the lead-ups to the 2001 and 2008 downturns, real estate-focused hedge funds have become more adept at sourcing quality long and short opportunities as rates rise and property-linked income levels off.
But perhaps due to the hedge fund industry's headwinds and the limited pool of managers specializing in real estate, comparatively little is known about these specialty strategies. They do, however, represent an attractive late-cycle option.