Changing capital allocations. Case Study: Private Equity
Using a Black Litterman portfolio optimisation model we simulate future optimal CRE allocations for private equity fund global commercial real estate portfolios. We predict a rotation towards specialist sectors and industrials by 2023
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We have analysed the change in global commercial real estate (CRE) allocations of private equity pre- and post-global financial crisis. Additionally, using an augmented Black Litterman portfolio optimisation model and forecast returns, we also simulate future optimal CRE allocations.
The result? Historically weighted towards office and specialist services, we predict a rotation by PE funds from office assets into industrials and an increased weighting of specialist sectors by 2023. Retail exposure could fall to just 8%.
These forecast changes in sector exposures for private equity investors could provide opportunities for other investors to access stock as a large volume of assets are rotated out of portfolios.
Based on the portfolio optimisation model for private equity, in absolute values, the office sector will see the largest amount of stock traded out of portfolios by private equity investors. Approximately $110 billion worth of office stock would need to be traded globally in order for private equity’s exposure to the office sector to be reduced from 38.7% in 2018 to 21.1% in 2023*. Core and core plus investors are likely to be the key benefactors of this divestment as a number of these assets being traded will have been repositioned to a core or core plus standard.
Largely due to structural headwinds, the retail sector could see approximately $54.0 billion of stock traded out of portfolios by private equity owners. Specialist retail investors or investors seeking change of use are the most likely future owners of these assets.
On the back of strong structural tailwinds fuelling income growth, the industrial and alternatives sectors are expected to see a net increase in investment of $89.0 billion and $93.0 billion respectively. It is envisaged that these investors could construct sizeable portfolios in these sectors, which will be on ultimately on sold to core investors once the assets are repositioned into stabilised platforms.
*Assumed growth in PE holdings of 55bps p.a. from 2018 to 2023. This is based on the historical growth rate of 2007-2018 which takes into account both a downturn and expansion phase.