Future Returns: Investing in Real Property Amid Inflation

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A decade ago, investors were more likely to broadly characterize real estate and infrastructure as sound investments. Today, inflation, rising interest rates, recession prospects, and supply-demand imbalances, require a more careful approach.

“When we think about real estate and the opportunities there, there’s a lot of dispersion,” says Joanna Berg, senior alternative investments strategist at BNY Mellon Wealth Management in New York. “Not every single [investment] is going to be a great inflation hedge.”

Multiple routes exist to invest in real estate—from actively buying properties to passively investing in funds or syndicated deals—but these approaches don’t offer equal inflation hedges. 

“There’s more opportunity on the active side than just passively investing into the asset class for total return and for an inflation hedge,” she says.

For instance, Berg notes that based on present supply and demand, it is easier to adjust rents higher in residential properties than offices. That doesn’t mean investors shouldn’t explore the latter.

“There could be some bright spots in certain areas of office space,” she says, suggesting some modern properties in select markets may be still in demand. Certain industrial real estate categories are also poised to offer a better future outlook and performance than their peers.

This requires investors to approach real estate and infrastructure allocations selectively. BNY Mellon clients are increasingly interested in the sector, as are others. According to London-based real estate consultancy Knight Frank’s 2023 wealth report, one-third of high-net worth investors are looking to increase their residential holdings, while 28% want to increase their commercial property holdings.

In a recent interview with Penta, Berg identified how investors can critically evaluate and invest in real estate and infrastructure opportunities as a hedge against inflation.

Seek Supply-Demand Imbalances

“Differentiation and dispersion are the key here when looking at real estate as an inflation hedge going forward,” Berg says. It’s necessary to look for sectors that have a supply-demand imbalance behind them to contribute to asset value growth.

Berg says one of these areas is multifamily properties, particularly in cities or suburbs benefitting from high population and wage growth.

Opportunity zones—distressed areas that offer potential tax benefits to investors—may provide interesting investment options for clients comfortable with the added risks, Berg says. Investing in these opportunity funds is for “clients who have capital gains that they want to roll into these funds, and that are okay with a longer lockup in terms of this investment,” Berg says.

Another promising area is industrial real estate such as warehouses and data centers that straddle commercial real estate and infrastructure categories. 

Berg also notes that infrastructure assets such as cell towers and utilities typically have inflation step-ups built into revenue streams through contracts or regulation. This helps make these assets “a great inflation hedge,” beyond their lower risk profiles and predictable returns.

Align With Overall Portfolio Needs

Berg says investors need to consider their portfolio’s liquidity requirements first, then align their investments to fit. For instance, if an investor aims to dedicate a certain percentage of their assets to private markets, they can include real assets as part of that allocation.

“That’s where you can potentially fit those more private equity-like funds that take a more opportunistic look at real estate, where you can get the inflation hedge but also the total return from those assets,” she says.

An income-focused strategy, Berg adds, makes it necessary to move to investments with lower risk-return ratios such as core (high-quality, class A properties with strong tenants) or core-plus (similar to core but in weaker locations) investments to avoid long lockups.

Accessible and liquid open-ended funds could contribute to the income component of the portfolio, without clients having to worry about locking up capital for extended periods, she adds.

“It comes down to fitting the liquidity profile, if clients are able to take more risks to get more opportunistic returns.”

Returns Can Be Found at Home and Abroad

Since the end of 2021, BNY Mellon has been offering strategies to hedge against inflation and rising rates, including real estate investments. “At this point in time, not only are we saying this is a great inflation hedge, but we actually have seen it play out,” Berg says.

For instance, the 10-year capital market assumptions for U.S. core real estate improved from 4.7% in 2022 to 6.0% in 2023. In the bank’s most recent outlook, it noted the potential for rising real asset prices and recommended opportunistic real estate allocations “to take advantage of dislocations that may occur globally as central banks continue to reduce liquidity and increase the cost of capital.”

Some longer-term opportunistic investments have international components, Berg says, especially in infrastructure. Nonetheless, most investments in the space are closer to home.

“The majority of our real estate investments are in North America,” Berg says. “Especially on the core real estate side. The markets are so deep here that there’s plenty to do.”

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