Despite these challenges, the fundamentals of real estate are showing signs of improvement. Strong demand from occupiers, better lending conditions, limited supply, and a growing yield premium compared with government bonds are driving renewed interest in the sector. Taking a hybrid approach may be an appealing option for investors who are returning to the market.
The liquidity mismatch
Direct real estate funds have long faced challenges related to liquidity, particularly in managing investors’ expectations for redemption flexibility against the inherently illiquid nature of the asset class. To mitigate liquidity risks, daily traded direct real estate funds typically maintain high cash positions (10%-20%). However, this approach results in diluted real estate performance and inefficient capital deployment. The liquidity mismatch between investors’ redemption demands and the illiquidity of direct real estate assets became particularly apparent during events like the EU referendum, which led to forced fund suspensions or deferrals of withdrawal requests.A hybrid fund solution
A hybrid real estate fund offers a compelling solution, by combining direct real estate’s attractive risk-adjusted returns with the liquidity, diversification, and access to a broader range of real estate opportunities offered by global listed real estate. This hybrid structure addresses the evolving needs of investors who seek stability and flexibility. It’s particularly useful for UK investors who want international exposure and for global investors who are looking for enhanced diversification.
The chart below illustrates the proposed hybrid fund structure compared with a standard global or UK real estate fund structure. It highlights how the hybrid model rebalances exposure to enhance liquidity, without significantly reducing the real estate allocation.
Comparing a standard global and UK real estate fund structure versus the proposed hybrid fund structure
Key benefits of hybrid funds
- Liquidity and stabilityDirect real estate provides stability by shielding against short-term market fluctuations, while listed real estate offers liquidity without triggering forced asset sales. This balance ensures portfolio resilience during market volatility
- Diversification and flexibility
Across markets and sectors
The hybrid fund offers broad diversification, spanning direct and listed real estate across various regions, sectors, and market types. Listed real estate provides access to global real estate markets, including high-growth sectors.
Dynamic and tactical asset allocation
The hybrid model is adaptable, allowing the fund to adjust its exposure based on market conditions. During market distress, the fund can increase cash and listed allocations for liquidity; and in more favourable conditions, it can lean into direct real estate for growth. The fund can capitalise on arbitrage opportunities and tactically adjust allocations.
- Faster investment deploymentListed real estate allows for quicker deployment of capital into the real estate market.
- Thematic and niche investment exposure
The hybrid approach opens the door to niche real estate sectors and thematic investment opportunities. These may be challenging to access through direct real estate alone as opportunities may be scarce, such as life sciences.
The listed real estate market offers investors exposure to sectors that are likely to benefit from structural trends and niche markets. While there are sector-specific direct real estate funds, these are typically available to institutional investors. For retail investors, direct real estate options generally remain diversified or balanced. In contrast, listed real estate platforms allow for more targeted sector exposure, supported by specialised expertise and scalable operating models. These offer a competitive advantage that is difficult for many direct strategies to replicate.
- Reduced volatility through diversificationWhile listed real estate tends to exhibit higher volatility in the short term, it correlates more closely with the performance of direct real estate over the long term. This long-term alignment of returns makes the hybrid structure a powerful tool for reducing volatility, while still providing attractive risk-adjusted returns.
Why is this the right time?
For decades, investors and regulators have bemoaned the lack of liquidity offered by real estate strategies. But there is a new solution that could finally give investors an opportunity for scale. Investors can now access more liquid real estate using hybrid funds, while taking on just a small increase in portfolio volatility to achieve the desired liquidity. Furthermore, over the long term, listed real estate returns have been shown to deliver similar returns to direct real estate, meaning investors are not diluting their overall return ambitions, either.
So why now? The hybrid real estate fund model presents a timely opportunity for investors as they look to diversify their portfolios in a dynamic market environment. The world is changing and investors need to recalibrate their strategies to ensure they are capturing the best risk-adjusted returns available to them.