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Even as shifting capital markets prompt periodic reevaluations of portfolio allocations, real estate has provided notable benefits to institutional portfolios, offering stable returns, inflation-hedging capabilities and diversification advantages.

Institutional investors are targeting, on average, a 10.7 percent allocation to real estate, but their current allocation is 80 basis points lower, at 9.9 percent.1 Interest rate–driven declines in real estate portfolio values, combined with the strong performance of public equities in 2023 and 2024, contributed to an under allocation to real estate. US private commercial real estate’s Open End Diversified Core Equity (ODCE) fund delivered a -12.0 percent total return in 2023 and -1.4 percent in 2024, after 13 consecutive years of positive returns. Public equities delivered 26.3 percent in 2023 and 25.0 percent in 2024, further widening the allocation gap, but recent public market volatility could offset some of the difference. Despite an under allocation to real estate, institutions have largely refrained from making additional investments during the past two years. Concerns about elevated interest rates, muted transaction volumes and write-downs were stalling new capital allocation.

Despite current capital market challenges, fourth quarter data signaled real estate values have mostly aligned with the current cycle and transaction volumes have started to pick up. After more than two years of adjusting to higher interest rates, capital returns in most sectors turned positive during the second half of 2024. Improving capital market conditions and stabilizing debt costs supported commercial real estate transaction activity during the fourth quarter of 2024, which according to MSCI-RCA, was 40 percent higher than fourth quarter 2023 levels. Total 2024 volumes also exceeded 2023 levels by 12 percent. Transaction volume, aside from politically induced macro-volatility, is poised to continue to grow in 2025, generating more conviction that markets have bottomed out.

As debt markets thaw and transaction volumes rebound, we can expect allocations to real estate to pick up again; however, escalating geopolitical tensions could potentially delay the anticipated recovery. Downturns are rare in private real estate, which implies that the recoveries that follow them bring rare opportunities to establish a good basis and add diversification. Real estate remains a vital component of a diversified portfolio. Although the focus is now more nuanced, with a growing emphasis on sectors with strong long-term tailwinds, the asset class maintains a solid footing in achieving strong long-term risk-adjusted returns.