Real Estate in Institutional Portfolios: Challenges, Cycles & Opportunities

The real estate landscape has undergone dramatic shifts in recent years, with rising capital costs, lingering challenges in the office sector, and the rapid ascent of alternative property types reshaping investor strategies. Against this backdrop, institutional investors are rethinking how to position portfolios for resilience and growth.

Institutional Investor sat down with Brooks Monroe, Managing Director, Client Portfolio Manager at Invesco, sharing insights into the evolving market cycle, the increasing role of real estate debt, and the secular themes driving opportunities across demographics, technology, and global diversification. From navigating risks to capturing modern tenant demand, Monroe offers a forward-looking perspective on real estate’s place in institutional portfolios.

Institutional Investor: Given the slow recovery in core real estate, particularly due to challenges in the office sector, what sectors or strategies within real estate do you see as most attractive for institutional investors in the coming years?

Brooks Monroe: Real estate has re-priced, and we appear to be in the early stages of a new market cycle. The real estate down cycle that we've experienced over the last few years was largely driven by capital markets as the cost of capital sharply increased. Outside of office, real estate supply and demand fundamentals have actually remained reasonably healthy. Values are bottoming out and beginning to recover in most sectors. Although it's impossible to time the market, I think real estate should be in an attractive position moving forward for institutional investors with long-term investment horizons. Starting yields are much higher today than they were a few years ago. Fundamentals appear to be supportive of healthy cash flow growth and liquidity within the market has improved meaningfully. So, the foundation for a recovery is in-place, which provides a potentially compelling opportunity to take advantage of secular growth trends that are impacting a variety of different property sectors. 

II: How are you positioning your portfolio to capitalize on opportunities in alternative real estate sectors, such as data centers, life sciences, or logistics, and what are the key risks to watch in these areas?

Brooks Monroe: Although alternative real estate sectors are now beginning to get more broad-based attention, we've been focused on several of those sectors for quite some time. A significant amount of our firm's global investment activity over the last several years has been outside of the traditional property types. Secular trends within demographics and tech have driven several of our high conviction themes regionally, such as manufactured housing in the US, student housing in Europe and senior living in Asia Pacific to highlight a few. These are areas where we've forecasted and ultimately observed very favorable supply demand dynamics and at times an under representation of capital. Operational expertise is routinely critical to business plan execution in many of these alternative sectors. Importantly for us, we're often investing in these opportunities and alternative sectors through specialty operating companies that we've integrated into our firm's platform. Many of those are owned directly by our commingled funds, so that our clients are benefitting from the enterprise value that their capital is helping to create.

II: With private credit gaining traction as an alternative investment, how does real estate—particularly real estate debt—compare in terms of risk-adjusted returns and diversification benefits for institutional portfolios?

Brooks Monroe: Historical performance data for real estate debt actually screens very well on a risk-adjusted basis relative to other asset classes, including direct lending. Real estate debt can provide attractive and complementary performance characteristics for institutional portfolios, such as premium yields, attractive Sharpe ratios, and limited correlations with other traditional FI sectors¹. Real estate debt, however, has not quite received the adoption velocity that private credit has in recent years, despite the fact that the commercial real estate debt sector is the 4th largest income asset class globally². However, many institutional investors are increasingly open to learning about real estate debt and how it can provide day one income yields that could meet or potentially exceed their plan’s expected rate of return with potentially significant value insulation, low volatility and low correlations to their real estate equity and broader credit portfolios.

II: What trends are you seeing in real estate debt markets and how can institutional investors take advantage of dislocations or distress in the space?

Brooks Monroe: The last few years have been a great time to be a real estate lender. The combination of regulation induced retrenchment from traditional lenders, increased base rates, valuation resets, and record loan maturities has delivered incredible deal flow and attractive relative value. Although some refer to the recent environment as the golden age of credit, we view real estate debt as a strategic allocation within institutional portfolios rather than purely tactical.

Additionally, there are current improvements that are well underway in terms of benchmarking quality, investor access and optionality that are helping to remove some of the historical barriers for institutional investors in this space.

II: In light of evolving tenant preferences and technological advancements, how are you assessing the long-term viability and value creation potential of non-core real estate assets?

Brooks Monroe: A disproportionate amount of tenant demand and capital demand is commanded by high quality, highly differentiated real estate assets that are specifically curated for modern demand. That's not a new trend, but accelerations in demand evolution and tech advancement have certainly raised the bar in terms of tenant expectations. It’s also created a tremendous opportunity for assets that meet modern space requirements, including an evolving and expanding set of physical, locational and experiential attributes. When we evaluate value creation potential, we focus on business plan execution strategies that ultimately produce modern core assets. We aggressively avoid assets with incurable obsolescence, current or future. Sometimes we hear institutional investors overgeneralize the use and risk association of broad terms like “development” and “repositioning”. The inherent risk profiles are deeply nuanced and sometimes casually misinterpreted. We would advocate that appropriately structured positions within development can represent a better risk adjusted return profile than a large scale renovation project with a long dated business plan. Our firm's 30 plus years of development experience supports that thesis, and we will continue to lean into unique development opportunities that produce high quality modern assets and ultimately create real value.

II: What role do you see real estate playing in institutional portfolios as a hedge against inflation and market volatility, especially as traditional core assets face headwinds?

Brooks Monroe: Over the last 30 years, real estate net operating income growth has consistently maintained or exceeded the pace of CPI growth, and it's generated a .03 correlation to U.S. equities and a negative correlation to U.S. bonds³. I think private real estate is well positioned today to continue to play the same roles that it has for institutional investors for the last few decades, providing premium income yields, very low correlations, effective inflation hedging and total returns that fall somewhere between equities and fixed income over long time periods⁴. What's slightly different today is that investors have an expanded toolbox of options to build a real estate portfolio that appropriately serves the specific goals underpinning their real estate allocations, and each investor is slightly unique. What's also different today is that the underpinnings of secular demand themes have evolved and modernized, and it's critical that your real estate investments are positioned accordingly.