Diminishing Real Estate Returns are Driving Diversification and Risk: RICS’ Trillion Dollar Risk Forum

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 last downturn, material changes in the way that risk is managed have ensured the sector is better placed to weather complex and volatile markets. However, new research released today by the IRF highlights there is yet more to be done, with:

· Over half (57%) of investors citing style drift away from traditional investment strategy

· The same proportion, (over half - 57%), saying that their risk management processes are primarily driven by performance, but that nearly a quarter (24%) are driven by compliance

· 90% of respondents believe the industry’s approach to risk management has improved since the GFC

With changes to occupier habits, technology, and some major markets now trading on yields well below historic averages and, in some cases, close to all-time lows, respondents see investment moving away from traditional portfolios. More broadly, the sector is faced with automation.  Investors have been working hard to build resilience in the face of these new developments and disruptive change. 

With some investors believing that we’re nearing the top of the cycle, several are moving further up the risk chain. The 2007/8 Global Financial Crisis remains in the minds of investment managers, prompting an increased focus on risk management over the last ten years. However, investors are balancing this with a need to achieve returns. With some investors believing that we’re nearing the top of the cycle, several are moving further up the risk curve to achieve them. The results show that 90% of respondents believe the industry’s approach to risk management has improved since the Global Financial Crisis, 33% believe it has improved markedly, while 57% believe it has improved somewhat.

Concerns about lower returns for many retail, residential and office portfolios are motivating investors to request diversification away from the traditional and into secondary locations and alternative assets (such as hotels, student accommodation and PRS), in a move which is fundamentally changing the risk profile of investments. Alternative assets require further investment in risk management.

Although 90% of respondents believe that the financial crisis has acted as a catalyst for positive change when considering risk management - which in practical terms has manifested in businesses growing their risk management teams, greater integration of research within the risk management process and the introduction of new quantitative modelling techniques - challenges remain.

In response, the report offers solutions to improve risk management and support global stability through the greater use, and consistency, of data and enhanced levels of transparency.

RICS’ IRF, has identified three tangible solutions which will enable the industry to address these challenges and act as a broader catalyst for wider industry collaboration: 

1.     Establish a mechanism for cross-border sharing of quality, comparable real estate market data.

2.     Learn from other investment sectors to ensure greater leadership, and best practice in risk management systems and processes, drawing on lessons from other investment sectors.

3.     The industry needs to improve institutional knowledge sharing to ensure each new generation learns from the experience of previous cycles.

Commenting on the report, Martin J Bruhl FRICS, CIO Union Investment Real Estate  said: “The primary objective for investors is to generate satisfactory risk-adjusted returns. We, as an industry, bear a heavy duty to support responsible and sustainable markets. We must ensure a sophisticated and professional approach to risk management to ensure 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 not just look backwards but, also, to the future. The real estate investment management business has been accused of making long term investments with short term memories. The increased focus on risk management we are championing will hopefully be the start of addressing this criticism.”

Richard Stokes, Head of Global Corporate Affairs, RICS, added: Risk is, and always will be an essential part of any investment. But that must never come at the expense of responsible practice, which is vital to ensuring global stability. Ten years on from the global financial crisis, it is incumbent on us all to ensure the lessons of the past cannot be forgotten. Much progress has been made to enhance risk management approaches and, whilst there is more to be done, RICS Investment Risk Forum demonstrates genuine, global leadership and a desire to foster best practice in this area.