Last year, global investment fell to its lowest level for more than a decade. The first half of this year was even weaker. But are we close to a turning point in the real estate cycle? Investor sentiment surveys show more optimism, underpinned by growing evidence that property values are bottoming out. The macroeconomic backdrop is also improving; central banks are beginning to ease monetary policy, amid a broad-based decline in global inflationary pressures, and economic growth is accelerating.

But a recovery needs capital: where will it come from?

Some investors have been chastened by losses on existing portfolios, with an estimated US$2 trillion wiped off the value of global real estate markets since mid-2022. Facing the prospect of a paradigm shift in the market, many could be once bitten, twice shy. The fundraising environment remains very challenging as a consequence. New capital raised in the first half of this year was down 45% on the same period 12 months ago.

But in the short term, at least, there is enough liquidity in the system to support a recovery. Real estate funds have a significant amount of dry powder, much of which was committed in the years following the Covid-19 pandemic, when ultra-low interest rates supported a boom in real estate markets. This is true across the wider investment landscape. In the US alone, institutions have around US$3.6 trillion parked away in low-risk money market funds.

The opportunity cost of holding cash can be significant when markets turn. While investors have enjoyed a healthy return on cash – with US money market funds delivering a total return of 5.5% since US policy rates peaked in July last year – those who redeployed into US equities have enjoyed returns in excess of 20%, largely due to an AI-inspired equity bull market.

This unallocated capital can now be put to work. There is, after all, a whole ecosystem in place to support a more active real estate sector. In some markets, the best assets are already seeing competitive bidding. Pressure to deploy will only intensify as the major central banks lower policy rates, limiting the returns available on low-risk cash-like investments.

So if pent-up demand is the catalyst for short-term recovery, what will sustain it?

This is where pent-up supply should add fuel to the fire. In any given year, around two-thirds of investment activity is backed by investors with a strategy that actively considers a future exit within a broad timeframe, typically five to seven years. This supports a level of ‘churn’, as money returned to investors when funds liquidate their assets gets recycled back into the market.

The current cycle is characterised not only by a lack of buyers, but also a lack of sellers. ‘Motivated sellers’ have been rare, despite all the warnings of major debt distress and refinancing gaps, while discretionary sellers have been inclined to wait out the downturn, or ‘extend-and-pretend’, to avoid crystallising paper losses.

This is evidenced by the ‘turnover ratio’ for 2023, which provides an illustration of the amount of churn relative to the past. Last year, it dropped to a level not seen since the global financial crisis.

Global real estate turnover ratio

Source: Savills Research using MSCI RCA

However, comparing the volume of sell-side activity over the past 18 months, to buy-side transactions from five to seven years ago, suggests a large vintage of properties will be brought to market when the recovery does take hold, even while recognising that there is plenty of nuance around how investment funds manage exits through a market downturn like this.

The final question to ask is how institutional money, as the principal source of capital, is responding to the downturn?

The good news here is that institutional investors show no signs of turning away from real estate. Allocations have instead stabilised in recent years – and this should sustain churn in the market as pent-up supply is released.

A greater share of this capital may flow into debt funds, if traditional sources of finance become more risk averse, so reducing the amount allocated to equity strategies.

But we will also to see new capital flow into the sector. Ongoing structural shifts in the global economy will continue to swell the coffers of the major institutions backing real estate, such as pension funds and sovereign wealth, even if allocations remain stable.

The principal driver of this trend will be the global ageing population. UN figures suggest nearly 25% of the population is now over 50 – up from 16.6% in 1990 – and that this figure will reach one-third by 2050. People generally borrow and spend when young, save and invest when middle-aged, and divest and spend when old. A growing middle-aged population saving for retirement supports global savings and wealth accumulation.

With secular stagnation (again a function of demographic change) limiting productive investment opportunities, the real estate sector remains well-placed to offer these savings a home.