Hunting for yield: Have you considered commercial property and infrastructure?
Assets that exhibit defensive and stable yield profiles, along with strong growth potential, are obvious candidates for a long-term investment strategy.
In a low interest rate world, term deposits are likely to continue to provide poor returns for some time. Coupled with ongoing market volatility, investors are searching for assets that provide stable and consistent income. In this article, we discuss we explore two asset classes, commercial property and infrastructure, and explain why they are attractive to investors in their ongoing search for yield.
Commercial property: what to consider?
Commercial property has proven to be a popular choice among investors due to its defensive nature, diversification benefits and income potential. Below, we highlight some of the key attributes which make commercial property a compelling investment option during periods of economic uncertainty.
- Consistent yield: Unlike companies that rely on profits to generate dividends for their shareholders, commercial property generates income by leasing space to tenants on contracted leases that typically last for more than 12-months. Therefore, income yield generated by this asset class is more consistent.
- Price stability: Commercial property typically enjoys long cycles between downturns. Historically, 75% of the return on the investment has been generated from the yield rather than capital growth. Additionally, commercial property scarcity and the cost of purchasing this asset class mean that it doesn’t sell regularly. Therefore, it is less effected by short term gyrations in market sentiment like that which creates volatility for investments that sell every day such as shares. Commercial property prices are also more stable because a commercial property is a less emotive buying proposition than a house.
- Indexed to inflation: Commercial leases typically incorporate annual, fixed or market reviews throughout the term of the lease, meaning that the rent is continually rising, helping to offset the effects of inflation over time. The rate of increase is negotiated with the tenant when a new lease is signed and the type of review is subject to market conditions at the time. In Australia, many commercial leases also include a ‘rachet clause’. This prevents the rental price from falling during the term of a lease in the case of a market downturn, thus protecting investor returns.
Infrastructure: what to consider?
A noticeable rise in allocations to infrastructure over the past five years has been driven by investor search for yield, inflation hedging and low correlation with other asset classes. Below, we outline some of the key characteristics of infrastructure which make it attractive in times of market volatility.
- Consistent yield: With cash expected to generate increasingly lower returns, infrastructure will continue to be supported by ongoing capital flow.
- Flexibility: Global listed infrastructure plays many roles in an overall portfolio, such as diversification, relative value and liquidity. These characteristics are becoming increasingly recognised by sovereign wealth funds and pension funds globally, who are seeing global listed infrastructure as an important component of their overall infrastructure portfolio.
- Protection from interest rate hikes: Long-term debt structures in place by infrastructure companies mean they are obliged to refinance small portions of their debt in the short-term, with the option to refinance longer-term debt at favourable rates if market conditions allow this. Additionally, contracts and regulation are often negotiated on a ‘cost-plus’ basis, allowing charging structures to be increased in an environment of rising interest rates. If interest rates rise due to an increase in gross domestic product, then this provides natural economic support and an associated increased demand for infrastructure assets. Investors can choose to invest in infrastructure companies that have in-built protection through transparent regulation or long-term contracts with high quality counterparties.
What are the risks for investors?
The overall scale of risk when investing in both commercial property and infrastructure sits between bonds and shares; the income is more secure but has less capital growth potential than shares.
Although the search for yield is a positive trend, where commercial property is concerned it is pushing prices ahead of rental growth. This could lead to low rental growth assets when interest rates rise.
Similarly, changes in interest rates can increase the risks of infrastructure investment – changes in availability and funding price may impact asset performance. The different infrastructure classifications are also subject to varying risk profiles. For example, social infrastructure (i.e. assets including hospitals, schools and education) generate stable long-term cash flows, as they are provided on an availability basis. Demand-based infrastructure (e.g. communications/telecoms towers) however, is exposed to competition and dates rapidly compared to other infrastructure assets, due to the pace at which technology develops and changes, so there is a greater investment risk.
Typically, long term investors like commercial property for the stability it provides in an investment portfolio, the long investment cycle periods and high potential to generate yield.
Infrastructure is still a relatively new asset class and affords investors with exposure to the type of investments that have previously only been accessible by institutional investors.
In a low interest rate environment where investors are chasing yield, asset classes that exhibit defensive and stable yield profiles, along with strong growth potential, are obvious candidates for a long-term investment strategy.
About the author
Tim Humphreys is the head of AMP Capital’s Global Listed Infrastructure team, based in the Sydney office. He also leads the research effort of infrastructure companies in the Americas. Tim has over 15 years’ experience in the financial industry in the UK and Australia and is a skilled infrastructure analyst.
Michael Kingcott is the Head of Property Investment Strategy and Research at AMP Capital leading commercial property research and investment strategy.