Why private real estate in an inflationary environment?

Hotter-than-expected inflation is stoking investment opportunities in real estate. We believe real estate may be the right investment for today’s investor.

That conviction is based on five compelling factors: income, growth potential, volatility management, diversification and inflation protection potential.

Real estate has historically offered investors a higher level of income than other asset classes. It has generated strong risk-adjusted total returns with a risk/return profile that is different to other asset classes and typically with less volatility.

By offering capital appreciation and income opportunities when inflation rises, real estate has traditionally acted as a hedge against inflation. That is a persuasive narrative in today’s macroeconomic environment.

The annual rate of inflation in the US accelerated to 7.5% in January 2022 – the highest since February 1982 – as soaring energy costs, labor shortages and supply disruptions propelled the Consumer Price Index higher.

While some inflationary pressures are likely to fade as the Covid-19 pandemic ends, others may prove more persistent. On one hand, supply chain bottlenecks may be transitory in nature. On the other, energy prices have risen significantly and may likely stay that way for the foreseeable future. Additionally, long-term demographic trends and Covid-driven behaviors – chief among them the ‘Great Resignation’ as record numbers of people leave their jobs in the wake of the pandemic – could lead to a permanently smaller workforce and therefore stickier wage inflation.

Real returns

Real estate investments may be seen as inflation-proofed in a variety of ways. The value of real estate is derived fundamentally from the cash flow they generate. The higher the cash flow, the higher the value and the higher the returns to investors. In an inflationary environment, landlords often have the ability to increase rents and therefore cash flow.

Many long-term leases, such as those seen in commercial properties, typically have built-in rent escalators that protect real income generation. Additionally, higher wages tend to lead to more consumer spending, which is a plus for single-family and multi-family residential housing – one of the key areas of opportunity that we have identified in the market.

Further, as a direct real estate manager, we have the control required to manage rising costs. We can use our flexibility to improve operations and focus on new technologies to mitigate higher costs.

Finally, spiking labor costs, increased material costs and severe supply shortages have made the delivery of new buildings very difficult. As a result, it will be more difficult for supply to catch up with demand, leading to increased pricing power for landlord.

Fundamentally, we see a lot of alpha in the market. The pandemic has not caused a paradigm shift for real estate, rather, it has accelerated pre-existing trends.

High household savings ratios around the globe stand to re-inflate real estate markets as Covid-19 relinquishes its grip on communities and economies. That should drive demand for housing, ecommerce and services, giving further support to those sectors that rebounded the fastest and sharpest from the property price falls seen during the early days of the pandemic. We believe this trajectory has further to go.

Long legacy

As the recovery continues, selectivity becomes more important. Our aptitude in locating the best investment opportunities has been developed during our 88-year legacy in real estate investing. Today, we have unparalleled reach – a global real estate presence with strong local expertise.

Our strategies invest in tomorrow’s world. That is because they have been developed with an understanding of the structural trends that will shape and impact the future of real estate.

Our global cities strategy focuses on real estate in the most promising locations for future growth – from Austin, Texas to Berlin in Germany and Sydney, Australia. A robust proprietary research process filters the world’s cities based on four metrics: scale, transparency, stability and megatrends.

This pinpoints cities with a metropolitan area population of more than 150,000. Their real estate markets have the necessary liquidity, data availability, property rights and good transaction processes to facilitate investment. Their countries have adequate political and economic stability.

And, finally, we believe they are in the top 2% cities globally that are best positioned to benefit from global megatrends: urbanization, rising middle classes, aging population, growing economic power of the East, technology and sustainability.

As an investment manager, we are dedicated to sustainability. Sustainability objectives are integrated in our investment process and we are committed to having a net-zero carbon global property portfolio by 2040.

Dynamic segments

Our strategic focus is on the most dynamic segments of the market: industrial, housing and alternative real estate such as healthcare facilities.

One theme that drives the allocation is the exodus from coastal cities into the Sun Belt – across the Carolinas, Georgia and Texas. It will have implications for real estate values in many sectors, including housing, office, industrial and technology centers.

Healthcare transformation, meanwhile, is driving demand for life science facilities focused on medical research and medical offices to provide the aging baby-boomer generation of nearly 73 million people with innovative outpatient care.

Another powerful theme is the acceleration in the adoption of ecommerce, which continues to drive demand for warehouse leasing. For example, we own and manage One National, a 300,000-square-foot warehouse in Boston, Massachusetts, which Amazon is using as a middle-mile sorting center.