Where do you see the key investment opportunities in real estate?
Today there is a greater balance in terms of our allocation across the underlying real estate sectors. In recent years we’ve seen the opportunity to generate considerable alpha through sector allocations playing into some of the structural themes like growth of e-commerce. However, under the current challenging macro backdrop, we expect more focus on certain attributes in companies like balance sheet quality, earnings stability, pricing power and inflation-resistant rental/business structures etc. In our view, it is more important than ever to be selective which makes the case for active management in a period of heightened volatility.
How is the environment of higher rates, persistent inflation and a looming global recession likely to impact real estate allocations going forward?
While a weakening economic outlook will dampen expectations for rental levels and a recession would inevitably see some income lost to weaker covenants in many sectors, the long-term contractual nature of REIT income streams do provide visibility and protection. Moreover, inflation is explicitly passed through via annual rental uplifts in many markets. The likely result is that 2023 rental income streams will be higher than those of 2022 for many as higher inflation levels are passed through.
Higher rates will no doubt put the spotlight on companies’ balance sheets. The good news here is that the listed REIT sector is not in the same vulnerable place it was in before the GFC. Balance sheets have been fortified with lower leverage, stronger liquidity and continuous access to capital markets, which puts the listed real estate sector on considerably firmer footing.
Under a very challenging backdrop, the sector is now trading at levels not seen since the GFC. Historically this has proven to be a good entry point for longer-term investors in the asset class.
What role will real estate play within the overall alternatives landscape?
While real estate will not be immune to the changing macroeconomic landscape, we think its ability to provide more dependable income streams, diversification benefits given lower correlations to many other asset classes and inflation protection over time, should provide some comfort to investors. The benefit of portfolio enhancement by increasing risk-adjusted returns within a balanced portfolio by adding REITs makes the case for investing in the asset class regardless of market conditions. Real estate continues to provide an attractive, reliable and growing income stream for investors, something we expect to be rewarded over time.