#Market Strategy — 28.09.2021

Refocus on Real Estate

Our 2021 investment themes Q4 update

Theme 2

Vaccines, recovery and reflation


  • Investors tend to allocate heavily to stocks, bonds and cash, but often ignore or under-allocate to real assets – based on real estate, infrastructure and commodities.
  • In a low-growth, low-yield world, cash flow is king.
  • In the long term, the inflation regime is likely to shift away from the disinflation observed over the last 20+ years.
  • Focus on assets with a) an essential product or service, b) a positive real yield and c) consistent cash flows.


Cash flow is king in a low-yield, low-growth world

The current rapid recovery growth rate is unsustainable: at present, the global economy is experiencing a turbocharged recovery from the pandemic recession thanks to unprecedented levels of central bank and government support. But this cannot last. Inevitably, the “sugar high” of this abnormal boost to the global economy will fade in 2022 as the effects of this fiscal and monetary stimulus on growth start to wane.

Bond yields already signal concerns over future growth: the sharp decline in US 10-year Treasury yields from their 1.7% peak reached last March highlights that the bond market is concerned about the path of future growth. This contrasts with optimistic 2022 consensus US GDP growth forecasts, which remain elevated at over 4%.

Inflation should calm down, albeit remaining higher than in recent years: while we believe that the current US inflation spike is transitory, the market still expects 2.7% core inflation for 2022, substantially higher than in recent years. This points to US and Euro bond yields remaining well below inflation (i.e. offering negative real yields).

Target real assets that offer yields above inflation: we favour real assets that are cheap relative to bonds and cash, and can thus offer investors positive after-inflation yields.

Real Estate and Infrastructure offer inflation-hedged cash flows: both listed real estate (REITs) and infrastructure currently offer yields in the 3%-3.5% range, up to 3% above 20-year Eurozone Sovereign bond yields. As such, they are attractive relative to bonds and cash.

Low long bond yields are good for real assets: global real long bond yields remain close to all-time lows, thus offering unattractive future long-term returns. But these low rates are good for real assets, as investors refinance their debt at a lower rate, thereby increasing net cash flows.

Institutional asset allocation to real assets will increase: over time, pension funds, insurance companies and retirees will need to generate stable income without taking too much risk. In a world in which cash and bond yields remain so low, this will force investors to raise allocations to real assets and alternatives in a hunt for returns, a trend which is already evident.

Commodities offer an attractive “roll yield”: given the recent strength in commodity prices, led by industrial metals, oil and even lumber in recent months, we have seen a strong performance in our roll yield strategy based on energy and metals, gaining over 16% in the year to date. This remains a good strategy for generating income, being exposed to the term structure of commodity futures without taking a directional view on the underlying commodities themselves.


Bond-beating real assets

  • Improved liquidity for many real asset funds: one of the main reasons that investors mention for not buying exposure to real asset funds is the lack of liquidity, with lengthy lock-in periods. However, this aspect has improved of late, with a growing number of unlisted strategies in real assets now offering consistent liquidity and transparency.
  • Quality infrastructure assets are valuable and scarce: high demand for stable cash flow,   inflation-linked long-duration income growth in infrastructure assets is coming from pension and insurance funds (to partially replace bond allocations).
  • Residential, commercial real estate in high demand: there is also scarcity in growth pockets of real estate - industrial, datacentres, self-storage, and mobile phone towers.

Private and listed real asset funds are attractive

Not all real assets are illiquid: one of the main reasons that investors cite for not having an exposure to real assets is that these unlisted assets are illiquid. But this is not necessarily true because many unlisted strategies in real assets provide consistent liquidity and transparency.

Many real asset strategies are less volatile: numerous real assets, such as private infrastructure and certain segments within real estate, are based on hard assets (e.g. toll motorways and bridges). These are assets with predictable, consistent cash flows that do not vary much over time. This results in a lower volatility profile than for many listed asset classes, such as equities or High Yield bonds.

Infrastructure assets (transport networks, power and water utilities, energy storage and transport, renewable energy, mobile phone masts): attractive for their strong visibility on cash flows, inflation-hedging qualities and strong historic performance. These assets are in very high demand from pension funds and insurance companies to replace the yield component formerly fulfilled by Sovereign and Corporate bonds, and are thus scarce, supporting high valuations. Over the last 20 years, the Global Listed Infrastructure Organisation index has delivered an annual average total return of 10%. 

Private real estate: both residential and commercial real estate exposure is attractive for long-term investors in view of the above-inflation yields, inflation-hedging qualities from inflation-linked rents and the financing benefits from very low debt costs. There is also structural growth to consider in many areas of real estate and a structural scarcity of quality assets in sectors such as residential, industrial/logistics/warehouses, datacentres and self-storage.

Office demand is recovering quickly on the “return-to-office” trend: in the US, listed office REITs have returned almost 50% since November 2020, and over 7% on an annual average basis since 2003. European office REITs have gained 40% since November last year, and 5.4% on an annual average basis since 2006. BNP Paribas Real Estate forecast an annual average 5% return from European offices from 2021 to 2025.

Residential real estate boosted by scarcity: since 2010, European listed residential REITs have returned an annual average return of over 17%. In the US, housebuilding slowed in the aftermath of the 2008 Great Financial Crisis, creating an “underbuilding gap” of 5.5 to 6.8 million homes since 2001, according to the National Association of Realtors. In Europe, pandemic-fuelled search for space has driven renewed demand for single-family housing with outdoor space.