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Invesco Inclusive: Getting REAL

The search for assets that can offer some protection against inflation
With inflation emerging from a long slumber to become a giant bugbear once more for the global economy and investment markets, investors are intensifying their focus on the search for assets that can offer some protection against inflation.

With inflation emerging from a long slumber to become a giant bugbear once more for the global economy and investment markets – not only in and of itself, but in the context of the impact of the rising interest rates that are central banks’ instinctive pre-emptive strike on it – investors are intensifying their focus on the search for assets that can offer some protection against inflation.

The “inflation hedge” aspect of global direct real estate is certainly an attribute whose time to shine has come, argues Invesco. It has built a market for its Invesco Global Real Estate Fund as a conduit into an asset class with defensive characteristics that has historically delivered portfolio diversification from equities and bonds, and also from listed real estate and Australia-only direct real estate. But the strategy’s inflation-hedging ability is now also high on the agenda.

Global direct real estate can act in this way because managers are able to adjust the income through regular lease renewals, an ability that has been “demonstrated by historical performance in inflationary periods,” says Max Swango, managing director and global head of client portfolio management at Invesco Real Estate.

  • “Of all the asset classes, real estate has the highest correlation to inflation,” says Swango. “This correlation gets dragged down in times when inflation is low, but when inflation is high, typically greater than 3 per cent, the correlation increases. When inflation is greater than 5 per cent in the US, the real estate return correlation has been 0.83. That’s very high, but it’s exactly what we’re seeing playing-out in the US again now.”

    The primary reason why real estate is an inflation hedge is the ability to raise rents, Swango says. “As incomes are rising, property values are rising. Also, expenses are rising but in commercial real estate those increased expenses get passed-through to tenants, they’re not the responsibility of the landlord.”

    Inflation directly affects values, says Swango. “When you see cost-push inflation, as we’re seeing now, it is more expensive to build new properties, which means that fewer properties are being built. For owners of property portfolios, that lifts the value of your properties. And those properties that are being built, because they are more expensive to build, the rents required to justify those more expensive properties are higher; which, again, makes it easier as a manager to raise rents in your existing portfolio.”

    The inflation-hedge angle is on top of the existing attributes of global direct real estate that have been so attractive to investors, he says – primarily the strategy’s ability to deliver capital appreciation and stable income from high-quality tenants in more than 200 institutional-quality properties in major cities all around the world.

    “We have a tremendous, well-diversified portfolio of privately owned buildings, ranging from logistics centres to office buildings to medical research facilities,” says Swango. “It offers strong diversification benefits away from the equity and bond markets, the listed real estate securities market and Australian-only direct real estate holdings. The strategy has demonstrated a reliable low-volatility return profile across multiple cycles, and demonstrates the drawdown protection inherent in high-quality private assets.”

    Also buttressing support for the Global Real Estate Strategy is that it correlates strongly with rising interest rates. “If you look for leading indicators of strong real estate performance, historically, one of the strongest has been a rising interest rate environment,” Swango says.

    “In the last 30 years, the ten-year Treasury rate has gone up for at least three consecutive quarters seven times – this will be the eighth – and in the last six times that that’s happened, cap rates on real estate have actually gone down. The reason that that’s happened is because there has been so much capital market interest in getting into property.

    “When interest rates were going up, real estate fundamentals were good, occupancies were high, rents were growing and cashflows were growing, and so investors were willing to pay lower cap rates for that growing income stream. That is exactly what’s happened so far in this cycle – we’ve seen cap rates go down,” says Swango.

    Interest rates have risen to the point where “no-one is expecting cap rates to continue to go down,” he says; in fact, we’re already starting to see cap rates start to rise a little. “Every property type, every sector in every market in every country is different, that is one of the advantages of a global diversified portfolio, but generally speaking, cap rates are probably up anywhere from 25 to 75 basis points, depending on what types of property you own and who your tenants are, but so far what we’ve seen is, because real estate fundamentals are so strong, the growing cashflows have significantly overwhelmed whatever rise in interest rates and cap rates that we’ve seen. The resulting impact on value has been that values have continued to go up, because the cashflow growth has been so strong,” Swango says.

    All this and more is discussed in the new podcast series launched by Invesco Australia, titled Getting REAL, which takes a deep-dive into the diversification benefits of global direct real estate in an investor’s portfolio, the stability of real estate and the cashflows from it, and the protection that real estate can offer in the current inflationary and rising-interest-rate environment. 

    The podcast is available now and can be accessed here

    Simon Redman

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