Inflation Pressures and Real Estate Opportunities
Art by Melinda Beck
Fueled by fiscal stimulus and easy monetary policy at historic levels, inflation has risen at its fastest pace in more than 12 months since June 1982 – rising to 7% in December, according to the Department of Labor (DOL). As more investors seek protection from the threat of rising interest rates, they are increasingly turning their attention to real estate and real estate investment trusts (REITs) as alternative sources of return.
Real estate is experiencing a dramatic upswing in an ever-changing investment environment, according to JP Morgan Asset Management’s latest Global Real Estate Outlook” Report. Over the next 12 to 18 months, the company expects real estate to continue to deliver strong risk-adjusted returns, with a significant inflation protection element in a rising interest rate environment – as long as economic growth continues unabated.
Historically low interest rates coupled with rising inflation are currently supporting asset class valuations and creating a “sweet spot” for core property investments, the outlook says. Since the economic recovery began in late 2020, there has been unprecedented fundraising by untraded private REITs and an acceleration in the rebalancing of institutional portfolios. As investors come under increasing pressure to find yield-producing assets, JP Morgan expects capital flows into real estate to pick up sharply.
According to the Defined Contribution Real Estate Council (DCREC) “Defined Contribution Survey 2021”.,“Interest in investing in real estate is increasing among defined contribution (DC) investors, with the average assets under management (AUM) of an investment manager managing dedicated DC real estate strategies increasing by more than 50% over the past five years and overall AUM rose by 24%
Almost half of the real estate investment managers who participated in the survey actively manage DC capital in their real estate portfolios. Another 47% of managers are considering or actively developing offerings for the DC market, suggesting that interest in the DC channel is growing every year.
In the current market environment, investors are concerned about whether returns on equities and fixed income are enough for DC savers and how to incorporate other long-term beneficial diversifiers, says DCREC Co-President Sara Shean. As more plan customization options become available, investors are also paying attention to what is structured in a way that makes it easy to include in a multi-asset portfolio.
The top reasons investors have shown interest in adding private real estate to their plans have been for diversification, risk-adjusted returns, inflation and downside protection, Shean says. Private real estate investments tend to hold up well when the market is more volatile. Because they move slower than the rest of the market, they don’t oscillate up or down and can help “cushion” the ride in a typical portfolio, she explains.
Additionally, Shean says, over the past 10 years, the industry has made great strides in standardizing many of the operating principles and mechanisms to make private real estate offerings more attractive to the DC market.
Interest within the industry has shown that investors want to be able to add properties to custom target dates, standard target dates or balanced funds, Shean says. Typically, a combination of public and private real estate is offered in the DC space for multi-asset portfolios.
Especially with private real estate, it’s best to combine them into a multi-asset solution that has liquidity from other options within the fund because it’s an illiquid investment, Shean says. This protects participants from times when they need liquidity to conduct transactions.
“Private real estate lies exactly between fixed income and equity. So it gives you the benefit of income, like fixed income, and it also gives you more of the benefit than fixed income,” says Shean. “It kind of sits right in between and it’s a very smooth ride.”
On a standalone basis for DC plan investors, REITs would work best and are beneficial because they’re fully liquid and an efficient way to access commercial real estate markets, Shean says. Because REITs are traded and valued daily, they are more volatile but tend to outperform private real estate slightly over the long term. REITs can also be offered in multi-asset solutions and in some cases align well with private real estate, which can help in more volatile markets.
When investors use REITs, they are investing in office properties, apartments or self-storage, all of which are business and macroeconomically driven. REITs aren’t the same as owning a home or townhouse, a common misconception, Shean notes.
Additionally, according to JP Morgan, historical performance supports the case for using REITs for their inflation-hedging and income-generating properties. During 83% of the periods of rising interest rates between 1992 and 2020, U.S. REITs delivered positive total returns, and U.S. REITs also outperformed the S&P 500 in 50% of those periods.
As long as supply-demand dynamics remain healthy – and the economic recovery is not derailed by new coronavirus strains or undermined by poorly controlled inflation over the next 12 to 18 months – real estate investors should provide a steadfast source of alpha, income and diversification, says JP Morgan.