Alternatives to Fight Inflation in Real Estate in Infrastructure

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Larry Antonatos, managing director and portfolio manager, Brookfield Asset Management.

With respect to other real estate sectors, the pandemic created both headwinds and tailwinds, and these headwinds and tailwinds are continuing to wane as the pandemic fades and return to normalcy progresses. I do want to say that one factor that is supporting the real estate market and the infrastructure market in particular is that many of these assets are held in private hands. And investors have an incredible appetite for private real estate and private infrastructure, and that plays through to the public securities markets.

So within real estate, let’s think about some of the traditional asset classes. We’ve talked about office, but let’s also consider residential, logistics and retail. Residential has traditionally been multi-family apartments, but we are seeing strong growth in single-family for rent. This is driven by an overall housing shortage, coupled with continued rapid price appreciation for single-family homes. And those trends are actually supportive for growth and rental rates for both single-family rentals, as well as for multi-family rentals. Multi-family performed very well as did single-family during the pandemic, and we think those trends will continue.

Logistics was another area that was very positively impacted by the pandemic as many supply chains were disrupted. The importance of logistics was emphasized. Businesses have shifted from just-in-time inventory management to having more inventory on hand for more flexibility. There is a very competitive investment landscape for logistics as many investors see this as a truly wonderful asset class to be in right now. We find it very competitive and while we like the fundamentals, we see there is perhaps some slowdown in appreciation coming.

For retail, this is a sector that much like office was negatively impacted by the pandemic. We think the long term trends for retail in many ways are similar to the long term trends for office. Higher quality property located in the best markets will dominate. This is something that we have seen over many decades within retail, where the stronger retail with the highest sales per square foot continues to get stronger. Whereas, weaker retail draws fewer shoppers, but also fewer retailers and leads to long term decline in values and rents.

Where we are seeing some particularly attractive opportunities is in alternatives. These are things like student housing and life science buildings. Student housing could be considered a specialized form of residential, and life science could be considered a specialized form of office with high amounts of laboratory space, but really focused on research. We see these spaces as each having very strong, specific fundamentals, but also fewer investors participating. So the prospects for higher returns in both of these alternative spaces.

Now, shifting to infrastructure, same story as real estate, pandemic related headwinds and tailwinds continue to wane. One thing that’s very important about infrastructure is inflation. Inflation has been high for the past 18 months and we anticipate inflation slowing, but continuing to be higher than the prior 10 to 20 year average. And because many infrastructure assets have pricing mechanisms index to inflation will feel very strongly that infrastructure cash flows have a tailwind behind them of inflation indexing.

Thinking of infrastructure by sector, the fundamentals do vary by sector. Utilities, which dominate the infrastructure space should continue to very well, and particularly those that are focused on the clean energy transition should do well. We are definitely undergoing a transition from fossil fuels to renewables, that will require not only a change in generation of electricity from coal and oil-powered plants to wind, solar and hydro. But because those new wind, solar and hydro assets are in different locations, and because they are in some ways intermittent rather than consistently reliable. We need to improve and strengthen and make the electricity distribution grid more resilient. That will require capital spending by utilities, and most utilities are allowed to earn an attractive return on their capital base. So higher capital spending results in higher revenues. So that’s a great tailwind for utilities.

Transports, airport, seaports and toll roads definitely faced headwinds, a traffic slowdown during the pandemic. And that is slowly but steadily reversing with a recovery in traffic volumes across all of the transports. Energy midstream, which is principally oil and gas, storage and transportation, has been very much out of favour as the trend from oil to renewables has played out over the last five to 10 years. However, the Russian-Ukraine conflict heightens attention on energy security. The transition from oil and hydrocarbons to renewables will take decades. And in the meantime, we need secure sources of hydrocarbons, and the Russia-Ukraine conflict shines a bright spotlight on that. In particular, within our portfolio in the US, liquified natural gas export facilities are booming as Europe seeks to replace natural gas from Russia with natural gas from other sources, including the US.

Data infrastructure was a huge beneficiary during the pandemic. And we think that will continue to grow because data usage is increasing. It increased in a step-wise manner during the pandemic as everyone shifted to remote work and WebEx and Zoom calls. We think data consumption, particularly streaming data, movies, video, et cetera, will continue to drive demand and growth in the data infrastructure network.