Real appeal - Australian infrastructure and real estate in a low growth environment
This article, the first in a series of three, explores the opportunities direct infrastructure and commercial (non-residential) real estate present for investors in a lower for longer return regime.
Michael Cummings, Head of Australia and NZ Funds, Infrastructure Equity, AMP Capital
Greg Maclean, Head of Research – Infrastructure, AMP Capital
Michael Kingcott, Head of Property Investment Strategy and Research, AMP Capital
Tim Nation, Head of Real Estate Capital, AMP Capital
Jeff Rogers, Head of Investment Solutions at AMP Capital, CIO at ipac
Investors globally are facing a ‘lower for longer ‘environment for investment returns. This weak return environment is largely due to the lack of sustainable economic growth in OECD economies. Policy makers have struggled to reignite economic growth in the period since the Global Financial Crisis (GFC) – a task that has proved harder than anyone anticipated.
Stimulatory measures, including aggressive quantitative easing have left developed economies awash with liquidity. Despite record low interest rates in the United States (US), data from the US Bureau of Labour Statistics suggests that the required return on investment for capital assets is now at its highest level in 75 years. In short, very little of the stimulatory measures appears to be invested into generating economic growth.
In the absence of a marked shift in policy making, we anticipate this situation is likely to persist.
This article, the first in a series of three, explores the opportunities direct infrastructure and commercial (non-residential) real estate present for investors in a lower for longer return regime. The discussion is focussed on Australian assets. Australia’s proximity to relatively high growth in the Asia Pacific region provides opportunities to leverage to these asset classes, with commercial real estate, in particular, being the beneficiary of direct investment from China.
Investors turn to real assets for income and capital stability
Investment in direct real assets can offer investors equivalent and more predictable returns compared to listed markets at much lower levels of volatility. Of equal importance is the low correlation of direct asset valuations to listed markets. This provides an efficient means of diversifying portfolio risk. Consequently, investors are increasingly turning to real assets such as direct infrastructure and property, particularly, commercial (non-residential) property, to meet their investment needs.
According to the 2016 Preqin Investor Outlook – Alternative Assets H1 2016, institutional investors expect to allocate more capital to both infrastructure and real estate in the longer term.
Figure 1: Allocations to property and infrastructure are on the rise
||% of institutional investors planning
to increase their allocations
Source: 2016 Preqin Investor Outlook – Alternative Assets H1 2016
Long-term investors generally favour direct infrastructure and commercial real estate for the stability they can provide within a diversified investment portfolio and the visibility of the income streams they generate. In a low interest rate environment where the outlook for total return appears compressed, asset classes that exhibit defensive characteristics with a stable and rising income profile are obvious candidates for a long-term investment strategy.
In addition, investors worried about an inflation surprise arising from the unconventional monetary policy implemented by major central banks post-GFC are attracted to the tangible nature of real assets underpinned by land value or based on contracts associated with the delivery of essential services.
Direct infrastructure and commercial real estate should not be viewed as a substitute for a diversified portfolio that comprises a wide range of assets and strategies. The size of the allocation to direct infrastructure and real estate should be influenced by investors’ long-terms goals and fit with their capacity to deal with the less liquid nature of these asset classes.
Investors’ goals and constraints can also inform the type of assets and funds selected within these sectors. For example, portfolios built for retirees whose goal is the delivery of a stable and visible cash flow may display a preference for mature social infrastructure or real estate funds with a focus on long-term leases.
What could upset the real asset apple cart?
Both infrastructure and commercial property are defensive classes of assets, but, like all investments, they are subject to risk. More recently, we have witnessed some overpricing in infrastructure as well as over development in real estate.
The recent volatility in bond markets suggests interest rates are closer to bottoming out, which may moderate future valuation increases in real estate. However, the absence of inflationary pressures and ongoing patchy global economic momentum suggests a significant rise in bond yields in the near term is unlikely.
The spread between the real estate yield and the 10-year Australian bond yield is close to an historic wide, which provides a substantial buffer if there is a sharper than expected rise in bond yields. Listed market volatility could actually benefit prices by taking some of the pent-up demand away and helping to keep direct property values more stable.
The momentum in the Chinese economy is the other risk to Australia. At the moment, it appears to be muddling through, but there is downside risk due to local debt issues, and possibly slowing global economic momentum. This could transfer to Australia. A slowdown in the Chinese economy would likely be negative for our export sectors, but strong population growth, a lower Australian dollar and even lower interest rates, would help offset some of this impact.
The second installment of this three-part article series explores specific investment opportunities in direct infrastructure.