Sovereign wealth funds’ flows into real estate – particularly via pooled vehicles – have sharply dropped since 2015, underscoring a radical shift in investment strategy for the asset class, new research indicates.

At the same time, the state funds have ramped up direct solo investments in property, making the asset class the biggest recipient of flows of this type in the past few years, according to The Rise of Collaborative Investing: Sovereign Wealth Funds’ New Strategies in Private Markets, from Milan’s Bocconi University and the Boston Consulting Group.

Right after the 2008 financial crisis, property funds were capturing more than 50% of investment value and about 40% of deals, but last year allocations via real estate asset managers shrunk to just 5% of total investments in the asset class, said the study, released last week (see graph below).

The research found that 342 property deals were worth $111 billion in total from 2009 to 2018, making it the private market asset class posting the biggest inflows from in that period for SWFs (the bulk of which hail from Asia Pacific, including central Asia and the Middle East).

Real estate received an “impressive surge” of investment from the 2008 financial crisis until 2015, a record year when property attracted 50% of nearly $40 billion of total SWF flows into private markets, added the report.

SWFS INVEST LESS IN PROPERTY AND DITCH LP MODEL (Click for full view)
Source: Sovereign Investment Lab at Bocconi University

“The real estate binge, however, came quite abruptly to a close as the sector remained almost completely under the radar screen in the last three years,” it said.

This shift reflects the overarching trend for sovereigns and other big investors to allocate more to in-house capabilities and less to commingled funds as limited partners (LPs). But the biggest growth area in recent years has been co-investment rather than direct solo participation in deals.

“SWFs have recently started questioning high management fees and the heterogeneity of fund performance, and thus the validity of this conventional [LP] method of investment," according to the BCG-Bocconi report.

ABRUPT SHIFT

The shift away from the LP model was most abrupt in property investment, the research added.

The report's authors* said they were “observing [in real estate] to a greater extent than in other private markets a full-fledged disintermediation processes, with SWFs dumping LP models in favour of direct equity investments both in terms of solo and, more recently, of partnerships with like-minded investors or specialised property operators”.

“Co-investments do not appear a suitable investment model in this space,” the study added, “and the same holds for platforms that, in spite of a limited surge in activities in 2012-2013, never really took off.”

The ‘platform’ model involves SWFs teaming up with other sovereign investors or strategic partners to form funds or joint ventures with a specific focus or mandate.

The Bocconi-BCG findings are underlined by the latest annual review of the International Forum of Sovereign Wealth Funds (IFSWF), released in May.

“We are observing in real estate a complete departure [by SWFs] from the LP model,” Enrico Soddu, head of data and analytics at London-based IFSWF, said at the release event of the report. More than 90% of property deals are now being carried out through direct or co-investments, he added.

At the same event, Will Jackson-Moore, London-based global private equity, real assets and sovereign funds leader at consultancy PwC, said this trend did not come as a big surprise. 

“[Property is] probably the easiest asset class to transact in,” he said. “It’s relatively easier to operate an office building or a series of warehouses than a business with personnel and the complexities that entails.”

However, it's unlikely that most institutional investors will follow suit, and ditch the LP model. Most asset owners lack large SWFs’ internal investment capabilities and ability to take on such big tickets, so it's likely the will continue to act as LPs in property funds – particularly in markets they are less familiar with. Hence the increasing proliferation of more open-ended vehicles investing into Asia-Pacific real estate. 

* Bernardo Bortolotti, director of the Sovereign Investment Lab (SIL) at Bocconi University; Markus Massi, managing director and senior partner at BCG; Alessandro Scortecci of BCG; Giacomo Loss of the SIL; and Nikola Trajkov of the SIL.