Three reasons to invest in infrastructure or commercial property
This article explores why commercial property and infrastructure assets are attractive to investors in their ongoing search for yield.
In a low interest rate world, cash deposits are likely to continue to provide poor returns for some time. Coupled with ongoing market volatility, investors are looking for assets that provide stable and consistent income.
Investor search for yield, inflation hedging and low correlation with other asset classes has led to a rise in allocations to infrastructure over the past five years. Commercial property has also proven to be a popular choice with investors, due to its defensive nature, diversification benefits and income potential.
So how do these asset classes offer value in a low-interest rate and highly volatile economic environment?
Commercial real estate
- Consistent yield: Unlike companies that rely on profits to generate dividends for their shareholders, commercial real estate 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 than some other asset classes.
- Indexed to grow: Commercial leases typically incorporate annual, fixed or market reviews throughout the term of the lease, meaning that the rent is in many cases continually rising. 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.
- Price stability: Commercial real estate typically enjoys long cycles between downturns. Historically, the majority of the investment return has been generated from the yield rather than capital growth and is priced accordingly.
- Consistent yield: With cash expected to generate increasingly lower returns, infrastructure shares will continue to be an attractive way to access higher yields in a safe way. Infrastructure companies generate very stable cash flow each year and this allows them to pay out high and growing dividend payments to shareholders.
- Flexibility: Global listed infrastructure plays many roles in a portfolio, such as diversification, relative value and liquidity. These characteristics are increasingly recognised by sovereign wealth and pension funds, which view global listed infrastructure as an important component of their overall infrastructure portfolio.
Listed infrastructure allocations are increasing as investors allocate away from lower yielding bonds and also use this asset as safe bedrock to a global equity portfolio. Sovereign wealth funds and pension funds appreciate these characteristics and view global listed infrastructure as an important component of their overall infrastructure portfolio.
- Protection from interest rate hikes: Infrastructure companies tend to have long-term debt structures, and debt maturities can stretch out decades into the future. Typically, a large portion of the debt tends to be at a fixed interest rate and interest payments are therefore not sensitive to fluctuations in central bank rates.
Additionally, contracts and regulation are often negotiated on a ‘cost-plus’ basis, allowing charging structures to increase in an environment of rising interest rates and inflation. If interest rates rise due to an increase in economic activity, then this provides natural economic support and an associated higher 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.
The search for yield is a positive tailwind for commercial property, helping to lift prices., rental growth is lagging which could lead to pressure on property values for low rental growth assets if there is a sharper than expected rise in interest rates later in the decade.
Within infrastructure, regulation and contract security are key areas for analysis. Regulation varies significantly around the world and can change, so understanding the different regulatory environments is important.
Similarly, understanding the contracts that infrastructure companies have is crucial to analysing the long-term value of a company.
Typically, long-term investors like commercial real estate for the stability it provides in an investment portfolio, the long investment cycle periods and high potential to generate yield.
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.