Diminishing real estate returns are driving diversification and risk
October 11, 2017: Ten years on from the global financial crisis, RICS’ Real Estate Investment Risk Forum (IRF) challenges the industry to learn from the lessons of the past, as market dynamics create growing appetite for risk. The report comes as compressed yields and new all-time highs for real estate investment volumes, entice investors up the risk curve in a bid for greater returns.
Since the lastdownturn, material changes in the way that risk is managed have ensured thesector is better placed to weather complex and volatile markets. However, newresearch released today by the IRF highlights there is yet more to be done,with:
· Overhalf (57%) of investors citing style drift away from traditional investmentstrategy
· Thesame proportion, (over half - 57%), saying that their risk management processesare primarily driven by performance, but that nearly a quarter (24%) are drivenby compliance
· 90%of respondents believe the industry’s approach to risk management has improvedsince the GFC
With changes tooccupier habits, technology, and some major markets now trading on yields wellbelow historic averages and, in some cases, close to all-time lows, respondentssee investment moving away from traditional portfolios. More broadly, thesector is faced with automation. Investors have been working hard tobuild resilience in the face of these new developments and disruptivechange.
With some investorsbelieving that we’re nearing the top of the cycle, several are moving furtherup the risk chain.The 2007/8 Global Financial Crisis remains in the minds of investmentmanagers, prompting an increased focus on risk management over the last tenyears. However, investors are balancing this with a need to achieve returns.With some investors believing that we’re nearing the top of the cycle, severalare moving further up the risk curve to achieve them. The results showthat 90% of respondents believe the
industry’s approach to risk management has improvedsince the Global Financial Crisis, 33% believe it has improved markedly, while57% believe it has improved somewhat.
Concerns about lowerreturns for many retail, residential and office portfolios are motivatinginvestors to request diversification away from the traditional and intosecondary locations and alternative assets (such as hotels, studentaccommodation and PRS), in a move which is fundamentally changing the riskprofile of investments. Alternative assets require further investment in riskmanagement.
Although 90% ofrespondents believe that the financial crisis has acted as a catalyst forpositive change when considering risk management - which in practical terms hasmanifested in businesses growing their risk management teams, greaterintegration of research within the risk management process and the introductionof new quantitative modelling techniques - challenges remain. In response, thereport offers solutions to improve risk management and support global stabilitythrough the greater use, and consistency, of data and enhanced levels oftransparency.
RICS’ IRF, hasidentified three tangible solutions which will enable the industry to addressthese challenges and act as a broader catalyst for wider industrycollaboration:
1. Establish a mechanismfor cross-border sharing of quality, comparable real estate market data.
2. Learn from otherinvestment sectors to ensure greater leadership, and best practice in riskmanagement systems and processes, drawing on lessons from other investmentsectors.
3. The industry needs toimprove institutional knowledge sharing to ensure each new generation learnsfrom the experience of previous cycles.
Commenting on thereport, Martin J Bruhl FRICS, CIO Union Investment Real Estate said: “The primary objective forinvestors is to generate satisfactory risk-adjusted returns. We, as anindustry, bear a heavy duty to support responsible and sustainable markets. Wemust ensure a sophisticated and professional approach to risk management toensure the lessons from the past are learnt sufficiently.”
Philip Barrett,Global Chief Investment Risk Officer, PGIM Real Estate, said: “A robust risk management framework does notjust look backwards but, also, to the future. The real estate investmentmanagement business has been accused of making long term investments with shortterm memories. The increased focus on risk management we are championing willhopefully be the start of addressing this criticism.”
Richard Stokes, Headof Global Corporate Affairs, RICS, added: Risk is, and always will be an essential part of any investment. Butthat must never come at the expense of responsible practice, which is vital toensuring global stability. Ten years on from the global financial crisis, it isincumbent on us all to ensure the lessons of the past cannot be forgotten. Muchprogress has been made to enhance risk management approaches and, whilst thereis more to be done, RICS Investment Risk Forum demonstrates genuine, globalleadership and a desire to foster best practice in this area.