Adjusting to market volatility and girding for a recession, some family offices in the U.S. are hedging their bets by shrinking their exposure to hedge funds and boosting their exposure to real estate.
That’s one of the key findings of a recently-released 2019 report on family offices compiled by UBS and Campden Wealth Research. Principals and executives at 360 family offices around the world were questioned for the report, with one-third of them based in the United States. Nearly three-fourths of the family offices surveyed invest in real estate.
Globally, the report says, real estate experienced the biggest lift in portfolio allocations for family offices, accounting for an average of 17 percent of the pie. Meanwhile, family offices around the world trimmed their investments in hedge funds, bringing the total portfolio share down to an average of 4.5 percent, according to the report.
“We have been getting out of equities and putting money into bonds and real estate. We are also putting money aside to make purchases if there is a crash,” an unidentified family member of a single-family office in North America told the UBS and Campden researchers.
Close to one-fifth of family offices in North America will likely raise their real estate allocations on a net basis in 2020, forecasts Rebecca Gooch, director of research at Campden Wealth. She notes that direct investment in real estate represents 14 percent of the average portfolio of a North American family office. Real estate generated an average return of 11 percent for family offices in North America, the report shows. Among North America-based family offices, commercial real estate made up 56 percent of real estate investments and residential constituted 44 percent.
Falling out of favor among some family offices are hedge funds, with an average portfolio allocation of 6 percent among North American family offices, according to the UBS-Campden Wealth report.
“Family offices have doubts about hedge funds’ ability to protect wealth during economic downturns, and they dislike what some deem to be relatively high fees when compared to performance,” the researchers wrote.
Raphael Sidelsky, chief investment officer at W5 Group LLC, a single-family office with investment teams in New York City, Miami and Switzerland, says that within the real estate sector, his firm is focusing on co-living spaces and micro-apartments to capitalize on the rise of the “shared economy,” as well as the lack of supply versus pent-up demand.
Last year, W5 Group took a minority stake in German co-living operator Quarters, which recently embarked on a $300 million expansion in the United States. Over the next three years, W5 Group and Medici Living Group, the parent of Quarters, plan to develop 1,300 co-living units across the country. In conjunction with the Medici Living Groupjoint venture, W5 Group said in September that it bought a majority interest in The Highline at Union Market, a 315,000-sq.-ft., mixed-use project in Washington, D.C. where one-third of the residential units will be Quarters co-living apartments.
“Real estate sits between bonds and equities in the risk-return spectrum and should be an element of all well-constructed portfolios,” Sidelsky says. “High-quality real estate in a sector with strong demand, without excess supply that is not over-leveraged, can withstand an economic downturn well and then provide upside during a recovery.”
“We have a long-term investment mindset and are hands-on investors, so direct deals where we control our destiny are paramount,” he adds.
There seems to be a trend of family offices shift away from investing in real estate funds and switch toward making direct investments or co-investments in real estate, says Scott Kapp, a partner with law firm DLA Piper whose clients include family offices.
“In the past, family offices may have only invested through a fund or a fund of funds,” Kapp says. “Today, there is significant interest in direct deals and co-investment, as family offices have sought to reduce fees paid to increase their overall risk-adjusted returns and to have greater control over their investments.”
While family offices tend to concentrate on real estate verticals such as industrial, multifamily and office, some are taking greater risks in hopes of achieving higher returns through investment in retail properties, Kapp notes.
For his part, Phil Marra, U.S. real estate funds leader at professional services firm KPMG LLP, says family offices are chasing core or core-plus real estate investments that can produce good cash flow while simultaneously being able to ride out a recession, but they’re also hunting for opportunistic investments that can deliver enticing returns. Preferred real estate sectors for family offices include logistics and warehousing, data centers and multifamily, he says.
Fretting about “catching the falling knife” as this real estate cycle winds down, family offices generally are embracing lower risk investment strategies, Marra says. As such, the beleaguered retail sector largely remains on the sidelines for family offices, except for grocery-anchored centers, according to Marra.
“Retail developers and operators haven’t found the right mix yet to intrigue investors to come back into that marketplace,” he says. “That’s going to continue until we see a recession and then see prices drop where there could be enough price depreciation that’ll allow people to enter that market.”
Marra characterizes family offices as “smart money” investors who are proceeding cautiously as the current real estate cycle wanes.
“We are seeing family offices want to do more deals,” he says. “But in those deals, they want to have more control over the selection and the operation, given the timing of this market. They want to make sure that they don’t make a mistake and overextend in a particular market or product type.”