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Recent industry report found that diminishing returns are driving real estate investment diversification

A decade after the global financial crisis, the Royal Institution of Chartered Surveyors (RICS) Investment Risk Forum (IRF) has found that diminishing returns are driving real estate investment diversification.

In a new report which draws on responses to an extensive survey with follow-up interviews, the forum explores whether lessons from previous cycles have been learnt to mitigate future risk.

The forum comprises more than 40 of the world’s most influential real estate investors. It was established in 2015 to foster industry leadership and share best practice, with the aim of enhancing the industry’s approach to risk management.

The report aims to highlight trends and perspectives which influence risk management in real estate investment. TC Chetty, RICS country manager in South Africa, says it is designed to stimulate further discussion and act as a foundation for ongoing leadership in this field.

“A number of issues are raised, including concerns surrounding the availability and consistency of cross-border property data, a challenge becoming more acute as the industry grows internationally, and especially as investment volumes grow in emerging markets.

“Advances in risk management have come at a time when real estate investment has reached new all-time highs, when yields have been compressed and competition for returns is fierce. Against this backdrop, investors are observing a growing risk appetite, with moves into alternative, non-traditional assets becoming increasingly widespread.”

One interviewee in the survey said student housing used to be in the alternatives camp a few years ago, but is now being recast as traditional, so the definition of alternative is changing. A 2017 McKinsey report also reflected this momentum toward non-traditional asset classes such as student housing, data centres, healthcare offices, medical facilities and assisted-living communities.

“This move to alternatives is changing the risk profile of investments as hotels, student accommodation, healthcare and the private rented sector behave very differently from traditionally core assets such as offices,” Chetty says.

“They operate under different business models with different types of investors. However, when understood correctly, these assets create new opportunities for investors.”

The report also highlights a trend towards greater flexibility in the way properties are designed, managed and leased by occupiers. Co-working, flexible space is becoming more prevalent in the office sector, building on models like Airbnb and WeWork. As a result, leases are becoming shorter and more flexible, with covenant strength being tested in new ways. For investors the opportunity to acquire assets with long-term tenants in place is less prevalent.

Another challenge is that driverless cars will be a reality it the not too distant future, so investors with multi-storey car parks in their portfolios are now thinking about the risk and opportunities.

The forum notes that in 2017, the sector appeared better placed to manage and mitigate risk. Experiences of the last downturn have prompted material changes in the way investors are set up to weather complex and volatile markets.

However, there are areas which the industry must tackle to improve risk management.

These include doing more to ensure quality, comparable real estate market data is available across borders. There is a lack of quality benchmarking data in many markets, and it impacts on their ability to accurately compare asset, portfolio and fund-level performance between countries.

Based on current market conditions and sentiment, investors noted the top three risks to be:

Changing real estate occupation and use habits.

Unrealistic valuations.

New generations of employees lacking experience of property cycles.

Chetty says the forum concludes there is a need for greater leadership and best practice in risk management systems and processes, drawing on lessons from other investment sectors.

“The industry also needs to improve institutional knowledge-sharing to ensure new generations learn from the experience of previous cycles, and share innovative thinking, market insight and best practice.

“We need to share lessons, in particular on liquidity management, integration of research in the risk management process, and practical approaches to risk management.”

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