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Getting to net-zero by 2025 will require an enormous shift of capital. This can only happen if groups with leverage apply pressure to financial services entities that are at the coal-face of change.
The powerful inflation hedge of commercial property
The oldest asset class in the world, direct property, is experiencing somewhat of a renaissance amid a surge in inflation and the pursuit of lower-risk income streams. This was part of the discussion at The Inside Network’s Alternatives Symposium, held in Melbourne last week.
The sector has evolved quickly in recent years, with Invesco’s Ashley O’Connor highlighting the different approaches taken by institutions.
“In 2006, institutional investors wanted to go offshore to complement their direct real estate exposures. So, they went into private-equity-styled opportunistic property funds that were highly leveraged or included riskier developments. At that time, it was a poor decision. The GFC hit and there were substantial write-downs. It was diversification gone wrong. Only five years ago did they rebuild offshore allocations into the core direct real estate space,” says O’Connor.
He explained, “there are three key benefits for adding global real estate to a portfolio: 1. diversification; 2. stability; and 3. inflation protection. When introducing a 20 per cent allocation to global real estate, we estimate it enhances returns by 0.6 per cent a year and reduces risk by 0.2 per cent a year. The power of compounding over 20 years on a cumulative basis means you’re about 38 per cent better off.”
The biggest question has always been, when is the right time to invest in real estate? Is the sector exposed to rate rises as many experts suggest? O’Connor says, “Even the unluckiest investors have done reasonably well. If you take the worst timing to invest in US core real estate in 1990, 2001 or 2008, as long as you held it to today, you would have returned between 6.4 per cent and 8.1 per cent p.a. If you averaged in over five years from 2008 the return is 9.3 per cent a year.” So, the message here? Don’t be too cute about timing the market.
How real estate performs when inflation is high?
“Correlation between private real estate and inflation rates is positively skewed. So, it’s better to have private real estate in your portfolio if you are concerned about inflationary pressures. Will real estate cap rates expand if interest rates rise? Highly unlikely. Over the last 30 years, since 1993, there are seven instances when bond yields have risen. Rising long-bond yields are typically a sign of a strengthening economy, which causes stronger demand for real estate. The biggest driver is the strength of capital flows” says O’Connor.
Amanda Clegg from Invesco goes one step further and looks at office, retail and industrial real estate. She uses a framework that uses secular trends to guide her thinking – “consumer | live | innovate | connect,” or CLIC. The concept looks to break down the traditional sub-sectors within property and define them by the parts of the future economy to which they are exposed. Many may not fully appreciate the fact, but advisers can access some of the most powerful global themes, like innovation, biotech research and cloud computing, through an investment in real property.
“In the office space, we like office assets that are located in prime CBD, investment hubs, have strong ESG credentials, and we put a lot of thought into the future of offices i.e. impact of Covid,” says Clegg.
“A good example of an asset that is included in the portfolio is 430 West 15th Street New York. It’s where the world is going, a trendy, creative-type office – every building around it is owned or rented by Google. That provides us with confidence that we’re in the right area. We also think it’s important to consider the local population,” says Clegg.
“We have been reducing allocation to retail, because we have recognised headwinds in this sector. But not all retail is created equally. A barbell approach is used, where 60 per cent of the portfolio is allocated to where people ‘want’ to shop and 40 per cent is allocated to where people ‘need’ to shop. A great example of where people want to shop is The Shops at Crystals in Las Vegas, Nevada. All the key brands, Gucci or Prada are there. In fact, retailers have been fighting over retail. Sales increased because of the way leases are structured. The 40 per cent allocation to where people need to shop, on the other hand, invests in grocery-anchored centres,” says Clegg.
The decision to buy an existing property or to buy land and develop, is always the question. In general, Clegg says, “buying land and developing it has been better. Avion Burbank, Los Angeles, has been a good example.”
