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Property tenants are ‘saying one thing and doing another’

How institutional grade property can navigate inflationary periods
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“Better lucky than good” explained Max Swango, managing director of Invesco’s Global Real Estate Team when referring to the tailwind that has seen institutional-grade property become one of the most popular asset classes in the world. He wasn’t referring to bond yields, as many thought, but rather the massive shift in investment priorities and allocations that has occurred since the group started investing in the 1980s.

As questions around inflation and interest rates challenge every asset class in 2022, Swango reiterated that the primary reason that any investor, institutional or wholesale, invests in commercial property is on an expected return basis; that is, they expect to make money.

In the 30-plus years since helping establish Invesco’s capabilities, which have grown to more than US$80 billion ($108 billion) invested in the sector, the powerful force of pension and sovereign wealth funds have driven the popularity of the sector with many, including Australian groups, moving from no allocation in the 1980s, to 3 per cent and now, in 2022, to as much as 15 per cent of most portfolios.

  • The more powerful tailwind, however, may just be getting started, as renewed volatility and significant challenges to both bond and equity markets are seeing growing interest for the financial advisory and wholesale markets. The biggest driver of this interest has clearly been inflation, with every adviser and asset allocator in the world seeking diversification.   

    While the common perception is that higher rates and inflation is a negative environment for real property assets, Swango presented real data that actually proved the opposite. In Invesco’s analysis, data showed that there was, in fact, a positive correlation between institutional-grade property and inflation rates, with this correlation only improving as inflation exceeded 5 and 7 per cent.

    There are a number of key reasons behind this inflation hedge, Swango explained, with “a significant jump in capital flows into the sector” one of them. After every boom and subsequent bust, the team, which has invested through four major global crises, has also seen a significant jump in interest.

    Property has a natural hedge in the form of CPI or fixed rental increases, which, given the importance of property to businesses, are widely accepted. On the other hand, the end of the pandemic is seeing both demand “pull” and cost “push” inflation. On the demand side, companies are “doing one thing and saying another,” he says, in terms of their commitment to the work-from-home trend. But not every property is benefiting; “only the best properties, with great locations and amenities,” are doing well.

    Among the most under-appreciated inflation hedges is cost-push inflation, which refers to the jump in construction and replacement costs for buildings. With shortages across the world and the cost of capital increasing, the cost of building new offices or other properties has increased significantly. With less supply, naturally comes higher rents.

    While many are concerned about the impacts of higher interest rates on valuations, Swango explained that of the last seven times that the 10-year US treasury yield increased for three straight quarters, commercial property capitalisation rates actually fell; which appears to be the case this time, as well. “If you invested into property when rates were rising, future performance was above-average,” said Swango.

    Among the most common misconceptions in the property market today is the so-called “death of retail,” and the “end of the office as we know it.” But Swango confirmed what many in CBDs are seeing, which is that the biggest technology and other companies in the world are “saying one thing and doing another. They are offering flexible work at the same time they are re-leasing property and in fact taking on more floor space.”

    The difference is the quality and amenities that new companies require, along with the more nuanced and granular property types, many of which simply didn’t exist in the 1980s. This spans everything from biotech and data centre properties, logistics, self-storage and specialised medical offices.

    On the topic of retail, Swango highlighted comments from luxury retailer Chanel, that it no longer requires seven stores in his hometown of Dallas, Texas; it only needs two; and “we want to own the two stores that Chanel wants.” This is likely the best description of the institutional-grade property sector and the future of investment in real assets in general.

    Drew Meredith

    Drew is publisher of the Inside Network's mastheads and a principal adviser at Wattle Partners.




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