COVID-19, inflation worries point investors to real assets

A global pandemic, inflation and supply chain issues continuing into 2022 are expected to point more investments into real assets, but from there industry experts say the crystal ball gets a bit cloudy.

In infrastructure, investors are expected to continue moving into core strategies, viewing infrastructure as a replacement for low-yielding fixed income and as a buffer for volatility caused by the pandemic, industry insiders say. Thirty core infrastructure funds worldwide raised a total of $15.6 billion in 2021, compared with 13 value-added infrastructure funds with a combined $36.6 billion and eight opportunistic infrastructure funds with $1.8 billion, Preqin data shows. Preqin has forecasted that infrastructure managers' assets under management will grow by a compound annual growth rate of 4.5% through 2025.

"Even three years ago, 70% of infrastructure money raised went to value-add" strategies, said Gordon Bajnai, a London-based partner and head of global infrastructure at placement agent Campbell Lutyens & Co. Ltd. Core and core-plus combined took 60% of world infrastructure fundraising in 2021, he said. "That's quite a switch."

"Only part of that is COVID-induced," Mr. Bajnai said. "Fixed income is down to negative or very low yield."

Institutional investors have a "massive part of their portfolios," he said. "You need to find something else to replace that return."

Seventy-five percent of the 50 limited partners surveyed by Campbell Lutyens in September and October indicated they plan to increase their infrastructure allocations. Fifty percent of respondents stated they planned to increase their allocations to core infrastructure, attracted by its resilience and yield, the survey showed.

In real estate, the reverse trend is anticipated to continue in 2022. Managers that had concentrated on investing in core — the safest properties — are starting to add riskier, value-added strategies, a trend expected to continue in 2022, industry insiders say. Some 121 value-added real estate funds worldwide raised a combined $53.1 billion, compared to 68 core real estate funds globally that raised a total of $15.6 billion as of Dec. 22, Preqin data shows.

Investors are still pouring capital into real estate as a yield substitute they find more attractive than bonds, said Nancy Lashine, New York-based founder and managing partner of Park Madison Partners LLC, a boutique real asset private equity placement firm.

With low capitalization rates — a measure of the rate of return properties are expected to produce — managers of open-end funds that invest mostly in core properties are switching to value-added, Ms. Lashine said. With the possibility of rising interest rates in 2022, these managers don't want to continue investing in core because the lower the capitalization rate, the more impact rising interest rates will have.

"Crystal balls are worth what people pay for them," said Ronnie Gul, Los Angeles-based principal of Mesa West Capital, a subsidiary of Morgan Stanley Investment Management.

Managers have been quite active making real estate deals in 2021, especially in the industrial, multifamily, student housing and self-storage sectors, and 2022 is expected to start out the same way, Mr. Gul said.

"We'll start the new year off where we'll end up, which is very busy and (real estate) people being very active," he said. "Where we go from there is an open question."

The tailwinds and investor interest in the hottest sectors such as industrial, multifamily and alternative property types like senior housing, student housing, single-family rentals and life science offices are not expected to abate because they promise to offer incremental yield, he said.

Mesa West executives worry about record high prices for properties in the most-favored sectors, he said. In light of factors outside of the real estate industry's control such as new COVID-19 variants and Federal Reserve interest rate policy, the big question is how long rents will continue to increase enough to make up for the rise in prices, Mr. Gul said.

"We worry about valuations and how sustainable the activity is," he said.

This is especially the case in industrial, which "is hot and has been hot for some time," Mr. Gul said. "How much gas is there in the tank in terms of increased values and increased rents?"

As for the alternative sectors, the capital flow into these property types is so strong that contractors cannot build enough of this kind of real estate to accommodate the demand, he said.

Another big question for real estate in 2022 is what will happen to the office sector, he said. It was supposed to have been a sellers' market in office in 2021 but the delta variant "took the wind out of the sails," shifting the balance of power to the buyer, Mr. Gul said. Office sales stopped because sellers did not want to sell properties at a market-clearing low price.

Office had been a big component of the largest real estate managers' portfolios until the pandemic, and at some point, these managers will have to start investing in office properties again to maintain their portfolio diversification, he said.

Long-term offices leases are helping to keep rents coming in and protecting property owners from being forced sellers, he said.

However, an increasing number of office tenants have been entering into short-term leases because they don't know what their office needs will be in the future, said John D'Angelo, a San Francisco-based managing director and the real estate solutions leader for the U.S. for Deloitte Consulting LLP.

Overall, most global real estate executives think rents will increase across sectors in general over the next 12 months. Forty-three percent of respondents to a Deloitte survey of 400 real estate executives taken in July and August expect rental rates to grow between 1% and 10%, while another 29% expect rents to grow between 10% and 20%, 7% expect rents to be up more than 20% and 21% expect rents to be flat or decline in the next 12 months.

Not surprisingly, respondents in the data center, cell tower and industrial sectors were very positive about their revenue outlook in 2022, with 62% indicating that revenues would be "significantly higher," Mr. D'Angelo said. Some 40% of executives across all sectors thought their revenues would be up significantly, he said.

Real estate managers anticipate that this increase in revenues will make up for rising values and costs of building and maintaining properties.

"Industrial assets and input costs have gone up substantially, but rental growth continues to exceed expectations — up 10% to 15%," said Michael Levy, Dallas-based CEO of real estate developer and manager Crow Holdings.

He said that the risk for industrial now "is missing out on the opportunity" due to the pandemic-induced switch to companies warehousing just-in-case supplies and inventory from just-in-time delivery of goods and materials, Mr. Levy said.

"This unprecedented demand-supply imbalance will end at some point," he said.

Meanwhile, Crow executives are "focused on and interested in the disruption to the office sector," Mr. Levy said. "There isn't much of the kind of office space that companies want going forward ... COVID-19 is keeping people out of hermetically sealed office buildings."

More green and collaborative working spaces as well as technology-enabled buildings are just some of the new features in demand, experts said.

Cathy Marcus, a Madison, N.J.-based managing director and global chief operating officer and head of U.S. equity at PGIM Real Estate, expects a pickup in sales in the office and retail sectors in 2022 from a low base.

Along with the resurgence of these two currently out-of-favor property types, Ms. Marcus anticipates that the "recovery that has characterized the second half of 2021 is set to turn into a full-blown expansion period, distinguished by above-average demand and more widespread rental growth."

This expansion should take place in 2022 despite "a recent wobble in sentiment on the real estate asset class linked to supply chain issues, rising costs, inflation pressures and new COVID variants of concern," Ms. Marcus said.

Another favored sector, multifamily, is expected to continue to attract investor interest and dollars into the new year.

"Multifamily, particularly workforce housing, has become one of the darlings of the real estate industry," said Robert Hart, Los Angeles-based founder, president and CEO of TruAmerica Multifamily, a value-added apartment money manager.

On Dec. 7, TruAmerica Multifamily closed its first discretionary fund, the $575 million TruAmerica Workforce Housing Fund, surpassing its $400 million fundraising target.

Investors looking for durable yield will continue to invest in multifamily because of its undersupply compared with the demand, especially in areas of the U.S. such as the West Coast and southeast Texas, he said.

"It's definitely a hot business that is extremely competitive," Mr. Hart said.