To download and print the PDF version of this document, please click here.

Recent data suggest that we may be approaching a cusp of a major change in the CRE capital cycle, not just in Australia but in key international markets. Overlay cyclical and structural changes across different CRE sectors and an emerging question on the mind of some investors is:

If investors are anticipating the current CRE capital cycle to be toppish, should they be reducing their exposure to private CRE?

The answer depends on several factors including (but not limited to):

a)       Institutions’ individual constraints and risk appetites (e.g. investment horizon, liquidity needs, taxation, liability matching for DB funds) and the existing composition of their multi-asset portfolios. As each institution is unique, institutions will need to review their individual circumstances together with their stakeholders and advisors. Any discussions here are general in nature and do not take account of individual institution’s specific circumstances;

b)       Type and intensity of capital cycle downturn being anticipated; and

c)     The risk profile of their existing CRE portfolio and its individual components

d)     Reinvestment risk: Can investors easily reinvest in future what they’ve sold today


This paper focuses solely on factors (b), (c) and (d).

Based on historical evidence, investors should down weight their private CRE exposures only if they anticipate the downturn to be driven by a structural oversupply in the CRE space

If the market down turn is driven by structural CRE factors (e.g. CRE building boom-bust of late 80s & early 90s), then there is a good case for trimming entire CRE portfolios, starting with riskier CRE components first.


Whereas, if investors anticipate non-CRE factors to be driving a future down turn, then upping their weights to defensive, Core CRE would make more sense

If non-CRE factors are believed to be driving a future downturn (e.g. capital dislocation event such as Black Monday, Tech Wreck, Tequila or Greek Crises or a liquidity crunch like the GFC) which are likely to adversely impact other asset classes in the portfolio more than private Core CRE, then we believe institutions are well-served by retaining their private Core CRE weights above neutral, just as they would overweight other defensive asset classes.

This would likely involve reweighting CRE exposure from higher risk Value-Add[2] and Opportunistic investments in their CRE portfolio to lower risk Core elements. Value-Add (V-A) and Opportunistic (OPP) CRE investments are designed to enhance returns by going up the risk spectrum – great in an up cycle, not so when the cycle turns down.

CRE risk styles

Whereas defensive,  Core CRE elements of a multi-asset portfolio help reduce volatility in a multi-asset portfolio and are exactly the types of assets that institutions should ideally hold in anticipation of a non-CRE driven downturn.

This can be inferred from the chart below where the major asset classes (Equities, Bonds, Cash[3] and All-Property) are denoted by the larger points, whiles the key sectors within CRE are further denoted by smaller points.

Risk return profile

Thanks to its appraisal based valuation methodology, CRE displays lower headline volatility than Equities and Bonds which are mark-to-market daily. Naturally, cash has the lowest volatility but barely keeps up with CPI and is a drag on multi-asset portfolio returns, except during down markets. Within CRE, Regional Mall are considered the most defensive of all Core sectors and this is underlined by its low historical volatility.

If an institution still decides to downweight CRE in anticipation of a non-CRE driven downturn, then the target down-weighted CRE portfolio would ideally switch weightings from growth (higher risk) to defensive CRE sectors...

Over the long run, CRE growth sectors (e.g. Prime Office or Industrial) trades at a yield premium to defensive sectors (e.g. Regional Malls). This is to compensate investors for taking on higher risk as reflected in higher return volatility in growth sectors. Typically at the tail end of a cycle, however, this yield premium inverts (runs well below the long-term average) when growth sectors outperform defensive sectors as investors’ animal spirits take over.

Yield spread prime office

…which means overweighting Regional Malls and underweighting Prime Office and Industrials

For example, this was observed in the period immediately prior to the GFC when growth sectors significantly outperformed defensive sectors and the inverted yield premium grew to more than one standard deviation below the long-term average.  Nevertheless when the cycle eventually turned down, the positive yield spread reasserted itself sharply when Regional Malls held its value better than growth sectors in a downturn.

yield spread logisitics

…and holding onto or even up-weighting rarely-traded Regional Malls to avoid future reinvestment risk

Unlike the frequently-traded CBD Office sector, regional malls are tightly held and rarely traded which causes a future reinvestment risk for investors wanting to down weight today.  According to JLL Research, annual trading volume for regional malls approximate one regional centre (or three partial ownership lots) between CY02 and CY16, excluding M&A transactions[4]. Typically, only partial interests in any regional mall get traded and the average size of this is approximately A$250m. There are some years when nothing is traded in the regional mall space. This means that if an investor chooses to down weight regional malls today in anticipation of a downturn and decides to reinvest later when the market bottoms out, they would struggle to get that allocation filled, if at all.

Transaction volumes

For further information, please contact:

Rohan Shan

Manager, Investment Risk and Strategic Business Research

07 3360 3975

[1] Commercial here refers to ALL investment grade, non-residential real estate and not just the Office sector.

[2] For a definition of these CRE investment risk styles for funds, please refer to

[3] We have used the ABS CPI – 8 capital cities as a proxy for the cash return

[4] Large M&A transactions in CY03 and CY12 (e.g. Westfield and AMP Capital JV reorganisation) are excluded as they skew averages upward.

About QIC

Investment Capabilities

Knowledge Centre

Latest News

About QIC