Real estate remains a popular asset class for institutional investors seeking to diversify their sources of real returns. As the economic cycle reaches its late stages, where can investors find the best real estate opportunities? Has core real estate in the U.S. run its course?

At least half of a sample of 144 institutional investors intend to boost their allocations to real estate, according to a January 2019 survey of investor intentions by the Pension Real Estate Association and its counterparts, the European Association for Non-Listed Real Estate vehicles and the Asian Association for Investors in Non-Listed Real Estate Vehicles. And, only 9.3 per cent of institutional investors reported foreseeing a decreasing allocation over the next two years.

Analyst views are mixed. Some see weakness in certain U.S. sectors, particularly core real estate. Others wonder whether value-added situations are running up against construction inflation. Outside the U.S., prospects seem rosier, at least in select markets.

“Our analysis leads us to the uncomfortable conclusion that core real estate returns are in the process of a significant moderation,” wrote Scott Crowe, chief investment strategist at Philadelphia-based investment manager CenterSquare in a January research note, stating that U.S. core real estate fund cap rates were at record lows of below five per cent.

“Low initial cap rates are challenged by a steady build of new supply that has accelerated with the aging economic cycle,” the note said. “In fact, a unique feature of this cycle is that the ‘supply constrained’ gateway markets are those with the most cranes. The punchline of the late-cycle increase in supply is that net operating income growth for real estate owners has meaningfully decelerated even as the economy has accelerated.”

But J.P. Morgan Asset Management, in its 2019 outlook for alternative investments, sees the global supply-constrained gateways somewhat differently, acknowledging that compression in cap rates has accounted for much of the return on real estate since the recovery started in 2010 and the market is now “priced to perfection.”

It nevertheless suggested that in the U.S. the shift from core investing to value-added properties is at an inflection point.

“Driving the shift is a sizable rise in construction costs for property improvement or development that is thinning the return premium for construction risk, limiting the supply of new core properties and even allowing some stabilized, fully leased core properties to sell below the now elevated cost of building new unleased assets,” the outlook said.

Given the supply constraints, J.P. Morgan sees a boost in rental income in the U.S. as one opportunity. By contrast, outside the U. S., value-added situations seem the more attractive, at least in Europe, while core properties should benefit in a still-growing Asia, where the economy is in mid-cycle, the outlook said.

For Crowe, core can still be rewarding, but private funds are not the preferred vehicle. Instead, REITs more fully reflect forward cap rates and are trading at a double-digit discount to net asset value.

Beyond that, value-added projects that update older properties to reflect contemporary technological and demographic trends – such as a surge in renters, internet-based retailers and co-working spaces – make rents and net operating income a counterweight to flat or expanding cap rates, he said.

If the easy opportunities are gone and current assets will require more work to meet their return potential, what’s next on the horizon?  A glance at the skyline seems to portend nothing dramatic, according to one newish indicator. Rider Levett Bucknall’s crane index shows little change in the number of construction cranes sprouting up in North American cities since 2015.