Managers rebound strongly following pandemic slump

Raising new funds still may be a challenge, but real estate managers are already getting their investment groove back from a slump caused by the worldwide pandemic, resulting in their combined global assets under management increasing 13.9% to nearly $2 trillion in the year ended June 30.

This is the first year of double-digit growth in worldwide real estate AUM in Pensions & Investments' annual real estate money manager survey since 2018, with managers now breathing a collective sigh of relief that the 2020 downturn wasn't as bad as everyone feared, thanks to federal intervention.

Real estate assets for U.S. tax-exempt institutions also rose in the 12-month period but at a slower pace — 6.8% to $652.4 billion. By comparison, real estate assets managed for U.S. tax-exempt investors were up 2.9% in the prior 12-month period.

"June of last year … is where we started coming out of the deer-in-the-headlights moment from COVID," said Eric Adler, London-based president and CEO of PGIM Real Estate. "From late February to early summer, we were just expecting a much more dramatic downturn and shutting down."

Managers placed their bets on two sectors that had already begun their ascent before the pandemic — industrial and multifamily — and stayed away from retail and hospitality, which were being hammered by the global shutdown.

"As with everyone, we are cautious on office and retail and generally are cautious on urban gateway markets, which have questions about what they look like in a post-COVID world," said Mike Kelly, New York-based managing director and head of real estate Americas at J.P. Morgan Asset Management. JPMAM has been shrinking its exposures to these types of properties, he added.

However, JPMAM sees some investment opportunities to build or renovate creative offices in emerging technology nodes of growing cities, as well as in lab space, Mr. Kelly said.

JPMAM's worldwide real estate assets remained roughly flat at $54.5 billion in 2021, and its assets managed for U.S. institutional tax-exempt investors declined 3.2% to $44.7 billion as of June 30.

Managers have plenty of money to spend with $363 billion in dry powder, according to Preqin. However, the pandemic-induced economic downturn and the uncertainty around the future of some real estate sectors has caused many investors to pause new real estate fund commitments. Fundraising dropped 65% in the second quarter ended June 30 from the year-earlier quarter to a combined $18.9 billion.

By property type, the industrial sector had the most growth among the top 50 managers of U.S. institutional tax-exempt assets with a weighted average of 21.1% as of June 30, up 2.4 percentage points from June 30, 2020, the results of Pensions & Investments' 2021 real estate manager survey showed. Office had the largest drop, down close to 3 percentage points to 26.2% of total assets managed by the largest managers.

In June 2020, PGIM became very active investing in industrial and multifamily properties, Mr. Adler said. Industrial was boosted by online shopping that soared as consumers stayed home.

The firm's investments revolved around supply chains and locations across the globe where new facilities were needed, he said. As for multifamily, the pandemic caused many people to reconsider their living arrangements, he said. PGIM executives are particularly looking to invest in more garden-style apartments that provide more space, Mr. Adler said.

PGIM's worldwide real estate assets grew 6.5% to $126 billion in 2021, and its assets managed for U.S. institutional tax-exempt investors rose by 5.4% to $58.5 billion as of June 30, making it the third-largest manager by worldwide assets and second-largest by U.S. institutional assets in P&I's survey.

While it is definitely not business as usual with the rise of the COVID-19 delta variant injecting uncertainty into the investment process, some managers are starting to take on more risk.

Some real estate managers have been investing in regions that appear to be in recovery and in specialty real estate sectors that they expect to outperform in a post-COVID-19 world, such as single-family houses for rent, data centers and properties catering to the life science sector.

In the first half of 2020, PGIM Real Estate executives were conservative, sticking to core investments mainly in industrial and multifamily.

PGIM went into a "make sure you know what you are doing with every dollar" mode, he said. Then last summer, PGIM executives realized that the worst economic scenario had been avoided and its portfolio was in good shape.

Real estate managers' worldwide assets invested outside the U.S. grew 25.7% from a year earlier to $660 billion as of June 30 and were up 100% from five years earlier. Assets managed outside of the U.S. for domestic tax-exempt investors also grew by double digits, rising 21.4% to $42.4 billion in the 12-month period, and up 42.3% over the five-year period.

Starting at the end of 2020, PGIM executives began investing in riskier strategies, primarily value-add transactions in Europe and Asia, Mr. Adler said.

"In Asia, in particular, the way COVID-19 has been managed, the governments, for better or for worse, have been very consistent" in what they wanted to do, how they do it, how they support certain industries and the duration of the shutdowns, Mr. Adler said.

"It created a certain predictability. Tenants, buyers and sellers were more comfortable positioning themselves," giving PGIM executives the ability to enter into transactions, he said.

PGIM Real Estate's non-U.S. assets managed for clients worldwide rose by 5.5% to $20.6 billion in the 12 months ended June 30, with the biggest share of assets in the U.K. with $5.8 billion, followed by Central and Eastern Europe with $5.6 billion and Asia with $4 billion.

For their part, investors still continue to believe that real assets as a whole, including real estate, is "relatively attractive compared to other types of yielding asset classes," said Jon Pliner, New York-based senior director and head of delegated portfolio management with Willis Towers Watson PLC.

However, real estate capitalization rates — a measure of the rate of return properties are expected to produce — are low and future returns are likely to be below their historical average relative to other asset classes, Mr. Pliner said.

The NCREIF Property index reflecting unleveraged returns of primarily core properties was 3.59% in the second quarter, the highest quarterly return since the second quarter of 2011. The industrial sector overshadowed all other real estate types with an 8.88% return, the highest in the history of the index, NCREIF reported. By comparison, the NCREIF Property index was -0.99% in the second quarter of 2020, which was the lowest quarterly return since the fourth quarter of 2009, but up to 2.7% for the 12 months ended June 30, 2020.

The NCREIF Fund Index-Open-End Diversified Core Equity index return was 3.93% for the quarter and 8.02% for the year ended June 30. In 2020, the NFI-ODCE was -1.75% for the quarter and 1.33% for the year ended June 30. 2020. The NFI-ODCE is a measure of fund-level performance and can include leverage and cash balances.

Josh Herrenkohl, New York-based senior managing director in the real estate practice at FTI Consulting, said that the pandemic has accelerated trends that were already present for the past 10 to 12 years.

The question is which trends will persist into the future, Mr. Herrenkohl said.

"We're at a period in which some trends will be durable and others, less so," he said.

The industrial and data center sectors have done well, Mr. Herrenkohl said. But trends can be cyclical, he said.

Industrial was "a sleeper asset class" that took off due to e-commerce that was partly accelerated by the pandemic.

"At some point, it will level off as most trends do," Mr. Herrenkohl said.

Office is in a state of flux.

Although he doesn't think the office sector "is going anywhere," the pandemic caused company executives to rethink their need for and use of offices. With the success of working from home, executives learned that employees did not have to be under their supervision in an office to be productive, Mr. Herrenkohl said.

Before the COVID-19 crisis, offices were seen by tenants to fulfill four purposes: to provide space for people to work, help the organization build and sustain its corporate culture, facilitate ideation and to enforce employee accountability, Mr. Herrenkohl said.

"My view of the four objectives is that I think that … building culture and facilitating culture and ideation will be the focus," he said. The pandemic "proved that people can work from a lot more places than the office. We've moved away from companies' need to track people 9 to 5-plus," Mr. Herrenkohl said.

Some of the same trends are playing out in the REIT arena. Despite 2020 being a challenging year for global real estate investment trusts due to the pandemic's effect on the stock market, REIT managers' worldwide AUM grew by 31.5% to $551.1 billion and assets managed for U.S. tax-exempt institutions was up 26.3% to $125.7 billion in the 12 months ended June 30, according to P&I's survey results.

"As the economy started to reopen late last year … it's been a choppy return to normalcy," said Ji Zhang, New York-based portfolio manager and vice president of Cohen & Steers Inc. REITs were more negatively impacted by the pandemic than the broader market, she said. But many institutional investors saw the REIT downturn as a buying opportunity, Ms. Zhang said.

Private equity and other private market managers saw the dislocation in the market and bought companies and business units, Ms. Zhang said.

There was also a noticeable shift in flows over the last year to active managers from passively managed real estate funds due to how property types and regions performed in the pandemic, she said.

For example, before the pandemic Cohen & Steers executives were already cautious about offices in New York City because vacancies were up and new buildings were scheduled to be completed. A 5% to 10% drop in demand expected to be caused by the pandemic would make investing in New York offices even less attractive, she said.

By contrast, the vacancy rate in Singapore is very low and employers in the country have a bigger preference for their workers to be in the office than the U.S., Ms. Zhang said.

Cohen & Steers' global REIT assets grew by 47% to $57.3 billion, and its assets managed for domestic investors was up 63% to $7.5 billion.