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Real Estate

The outlook for real assets in a post COVID-19 world

By AMP Capital

Around the table with AMP Capital Chief Executive Officer Shawn Johnson, Global Head of Real Estate Kylie O’Connor, and Global Co-Head of Core Infrastructure Michael Bessell.

As the world begins to move beyond the spectre of COVID-19, a return to business as usual appears unlikely. The pandemic has left its mark on both the way we live and the economic forces at play.

Facing the dual headwinds of rising inflation and increasing interest rates, AMP Capital Chief Executive Officer Shawn Johnson, Global Head of Real Estate Kylie O’Connor, and Global Co-Head of Core Infrastructure Michael Bessell discuss how these factors could affect real assets into the future, where the opportunities may lie over the next 12 months and the outlook for sectors that have been particularly affected by COVID-19.

When it comes to the impact of interest rate increases on the value of real assets, Mr Johnson says an important consideration is the reset rate on any asset as it relates to changes in inflation. He adds that questions over whether the Reserve Bank of Australia (RBA) will follow the Federal Reserve System (Fed) in the pace and magnitude of interest rate rises will also be a factor, as will movements in the A$/US$ exchange rate.

Shawn Johnson, Chief Executive Officer, AMP Capital
Shawn Johnson, Chief Executive Officer, AMP Capital

“An important consideration is the reset rate on any asset as it relates to changes in inflation.”

Through an infrastructure lens, Mr Bessell says rising inflation is likely to have three effects. “Firstly, for infrastructure assets that are heavily levered with base rates not hedged, borrowing costs will rise. We hedge base-rate risk on a lot of the assets in the portfolio, so that may have less of an impact, but certainly with newer acquisitions borrowing costs will be higher.”

“Secondly, inflation feeds into prices. Some assets can reprice relatively quickly, while with others, such as regulated utilities, we only get to reset prices every five years. It will take longer for rising inflation to impact those assets, but it will also take longer for pricing adjustments to flow through.”

“Thirdly, inflation will impact the discount rate that investors are prepared to value and buy assets at. But as we don't price on a spot long-term rate and the long-term rate hasn't reduced as part of the discount rate as much, there is a buffer there and it will take some time to come through into valuations.”

However, Ms O’Connor says rising inflation could play well for real estate assets, which are often viewed as an inflationary hedge. “We’re able to increase rent through the cash flow. It depends on the asset, but those increases are typically either linked to annual CPI increases plus a percentage, or a higher fixed percentage. In terms of borrowing costs, most of our core funds carry relatively conservative levels of gearing, and many have hedging policies in place.”

Michael Bessell, Global Co-Head of Core Infrastructure
Michael Bessell, Global Co-Head of Core Infrastructure

“There is light at the end of the runway for the aviation industry with international borders reopening.”

Few sectors have felt the brunt of COVID-19 more than the aviation industry. But with international borders re-opening, Mr Bessell says there is light at the end of the runway, but he anticipates a “slow grind to get back to the long-term trend that's always been there for aviation”.

“In terms of airport valuations in Australia, the Sydney Airport bid resulted in a re-rating of the sector, however airport valuations are based on long-term forecasts, and that bid simply underpinned the fact that these are good long-term assets, and they will recover.”

In the real estate space, there is no topic more hotly debated than the future of the office, with the pandemic driving workplace flexibility. Ms O’Connor believes a hybrid working model is here to stay. “Businesses are aware that to attract and retain staff, high-quality premises are important so we’re still seeing demand from tenants for space in well located, modern office assets. There may be some nervousness around what future space utilization looks like, but we've also seen strong transaction evidence recently, indicating capital demand for assets of this nature.”

Global Head of Real Estate Kylie O’Connor
Global Head of Real Estate Kylie O’Connor

“Businesses are aware that to attract and retain staff, high-quality premises are important.”

Retail is another real estate sector that has been disrupted by the pandemic, which quickened the shift to online shopping. But Ms O’Connor says that with market penetration of online shopping at 16 per cent to 30 per cent in the US and UK1, and just over 10 per cent in Australia2, Australian retail is attracting attention from offshore investors. “We’ve seen renewed interest driven by the need for diversification from investors that pulled back from retail in recent years. Retail also has a relatively attractive return profile, particularly for high-quality, multi-use assets with diverse tenants.”

But while COVID-19 has been a headwind over the past two years there continues to be longer-term tailwinds at play. In the infrastructure space, Mr Bessell says he expects more investors to be looking up the risk curve to core-plus, value-add infrastructure, driven in part by super funds looking to restructure portfolios to outperform benchmarks. “For example, infrastructure health has been expanding and shifting into infrastructure portfolios, attracting longer-term investors driven by the potential they see in an ageing and wealthy population. Data and telecommunication is another area where a lot of smart money has been going. Working from home has driven dependence on fibre, telecommunication towers and data centres, but it’s still not a core asset class so that additional risk attracts a slightly higher return.”

 

“I think you'll see more investment in different logistics assets as policy makers focus on trying to prevent the sort of supply chain bottlenecks that have been a hallmark of COVID-19.” Shawn Johnson, Chief Executive Officer, AMP Capital

In terms of where the top opportunities may lay for investors in the next 12 months, Ms O’Connor picks retail from a real estate perspective. “In particular mixed-use retail assets that can exploit themes that are a flow-on from the pandemic: experiences, connectivity and people getting together.”

Mr Bessell opts for both airports and core assets within infrastructure. “Airports will do better because their recovery will underpin their valuations. But in a rising inflationary and interest rate environment, core assets like regulated utilities, where returns have suffered over the last few years as interest rates fell, will recover. As interest rates start rising the revenue there should be higher.”

And Mr Johnson sees logistics, both from a real estate and infrastructure perspective, as a key winner in the build back from COVID-19. “Globally we’ve moved to just-in-time inventory over the last 30 years, but the last two years have shown that the world cannot handle supply chain interruption. I think you'll see more investment in different logistics assets as policy makers focus on trying to prevent the sort of supply chain bottlenecks that have been a hallmark of COVID-19.”

1. As at December 2021, US Census Bureau, ONS, AMP Capital
2. As at December 2021, Source: ABS, AMP Capital


 

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