IPE RE Awards: Inflation hedging not a main driver of property allocation decisions
Inflation hedging is no longer among the top priorities for real estate investors, according to investors at the IPE Real Estate 2018 Global Conference & Awards.
A panel of investors argued that protection against inflation was no longer a main driver of asset allocation decisions, due in part to the low levels of inflation seen across the developed world in recent years.
Patrick Kanters, global head of real estate and infrastructure at APG, said: “When we think about how we implement strategies for our clients, although inflation is an important reason why they allocate to real estate, it is not the main drivers of portfolio construction.
“We allocate to strategies in which we think the supply-demand equation works and strategies that are capitalising well on megatrends.
“Eventually, these strategies will also provide an inflation hedge, but this is not at the top of our portfolio managers’ agendas.”
Kanters added, however, that inflation does come up in conversations with clients and that the academic evidence points towards a strong correlation between income from real estate assets and inflation protection.
“This has to be put in the context of an environment where we have seen an enormous decline of interest rates and capitalisation rates,” said Kanters.
Marco Plazzotta, chairman of the institutional investors committee of Assoimmobiliare, Italy’s real estate investors association, said: “From my perspective, real estate is an evergreen asset class.
“Ten years ago, the discussion was focused on capital growth and total return. More recently, we have been in a deflationary environment and the discussion has turned to yield recovery and long-term income.
“Perhaps, we have to be selective in how we in invest in certain countries, to protect the capital against higher inflation rates in the future.”
The US market is an example of where being is selective is important due to a bullish inflation outlook, he said.
Meagan Nichols, head of real assets investment group at Cambridge Associates, said the firm’s approach to inflation hedging consists of using a basket of assets, as opposed to purely real estate. “I don’t think there is really a perfect hedge, but we have found that putting together a basket of inflation-sensitive securities has more durability.
That basket would include things like listed natural resources funds, commodities, potentially gold as well as real estate, infrastructure and credit”, said Nichols.
“Our research has told us that the basket approach is the best approach, but it’s theoretical because we have not had a period of high inflation recently.”
Nichols argued that inflation hedging is only one of the many benefits of building a portfolio of real assets. “It’s also about getting durable income and achieving growth. There are many different reasons to put any real assets into a bucket,” she said. ”You will get some inflation hedging characteristics but you are also getting all these other attributes.”
Mark Roberts, head of research and strategy alternatives and real assets at DWS, added: “I think when investors look at real assets, one of the presumptions going into it is that they provide an income yield, which is needed today if you look at where bond yields are. The total return component is also very important, as well as diversification and inflation hedging.
“You might be surprised looking at some of the data on US apartments over a 30-year period. The correlation between income and inflation is 28%, but if you look at a rolling 10-year period, the correlation can be positive or negative. It is actually negative at the moment. In the last few years, total returns have gone up and inflation has come down. Where you are in the cycle matters.”
Panellists were asked whether the trend towards shorter leases enhances the inflation-hedging characteristics of residential real estate portfolios.
Kanters said: “I honestly think that the length of the rental contract is not as important as many might think. If you look at shopping centres, for example, investors have tended to favour long-term contracts. But if the retail sector is not delivering, then long-term leases are not helping.”
In academic evidence, residential yearly contracts appear to be the best in terms of inflation hedging, Kanters said. In essence, the length of the contract is not necessarily helpful, he said.
”That is not something we take into account. The trend in short-term leases is not having an impact on the inflation-hedging characteristics”, added Kanters.