Partner Insight: Building resilience into global real-estate portfolios

The macroeconomic background of rising interest rates has proven challenging for real estate over the past two years. The outlook remains mixed. While markets are pricing in rate cuts this year, a return to the very cheap cost of capital that characterized the period following the global financial crisis is unlikely. That reflects our view that sticky inflation will persist alongside weaker growth in 2024.

Against this complex outlook, our global team of more than 300 real-estate investment professionals have used their long experience and over 60 years of knowledge and experience of the market to focus on resilient sub-sectors supported by robust long-term structural trends rather than cyclical forces.

A collective thirst for data drives demand for data centres

Data centres are one of the pillars upon which our modern, knowledge-based society runs. The past decade has seen the migration to cloud computing drive the first wave of growth in data storage capacity. Our team of data centre investment specialists believe a second wave of expansion is being driven by the artificial intelligence (AI) revolution, creating increased demand for capacity across North America, Europe and the Asia-Pacific region.

The amount of digital data expected to be created over the next five years will be more than double the amount of data created since digital storage was first invented in 1956.^[1] At the same time, this highly specialized asset class requires expertise in site selection, power availability, and equipment – characteristics that represent high barriers to entry and limit the growth of supply. In the US, rising land prices, longer lead times for power and equipment, and labour shortages are all driving up construction costs and further dampening supply.

Opportunity knocks in European hotels

The European hotel sector is benefiting from surging demand as the travel and tourism industry bounces back from Covid-19. We anticipate that robust growth will continue over the long term, underpinned by greater global mobility, the rise of the middle classes in developing countries, and a mounting desire to devote more time to leisure activities and memorable experiences.

At the same time, "the structure of the industry in Europe is creating favourable opportunities for acquisition and repositioning", says Graeme McCormack, Head of Hotel Fund Management. He explains that this is because family-owned hotels account for the majority of rooms in Europe; by contrast, hotel chains have a much higher penetration rate in the US. Yet many of these independent properties have suffered from years of underinvestment. In 2021, for example, while independent, family-owned properties accounted for 57% of rooms in the European hotel industry, they received only 36% of total investment.

Currently, there is an opportunity to acquire these hotels at a discount with high inflation and rising interest rates exacerbating financial weaknesses caused by the COVID-19 travel shutdowns.

Graeme also noted that the strong performance of leisure and hospitality across southern European countries in particular is already attracting the attention of investors and global brands, especially in the luxury and economy segments.

Listed infrastructure poised to prosper

Emily Foshag, CFA, Portfolio Manager, Global Listed Infrastructure has a high conviction in the long-term outlook for listed infrastructure, based on fundamental growth drivers. She also believe that listed infrastructure should prove a relative winner in 2024 whether the global economy enjoys a soft landing or not. Should a recession materialise, listed infrastructure is likely to outperform as it did in the 2001 and 2008–09 recessions.

Yet listed infrastructure has also traditionally outperformed equities in an environment of decelerating growth alongside inflation that exceeds long-term averages – our base-case expectation for 2024. Importantly, given the relatively opaque economic outlook, listed infrastructure's history of offering lower earnings volatility and better cash-flow visibility than equities is also very appealing.

Moreover, valuations in the sector are trading at compelling prices, while the balance sheets of listed infrastructure companies remain solid, as long-dated debt is a defining feature of the asset class. According to Emily "pockets of dislocation have also created strong potential for share-price recovery". She cites renewables as an example, arguing that "returns on capital deployed in renewables development could be stronger than they have been in years, particularly for developers operating at scale".

Riding the green wave

Green properties are another area we favour. In many global markets, demand for buildings with sustainability credentials is accelerating, and the valuation delta between properties with a favourable ESG profile and those ignoring this structural change is likely to widen. Increasingly stringent regulation at an international, national and city level will continue to drive demand. Healthy rental premiums are being achieved for certified buildings across a range of global markets. We anticipate that tenants will increasingly analyse environmental performance indicators such as energy intensity and electrification, on top of green credentials, when looking for office space.

In summary, these sectors experience different dynamics, but all are characterized by robust demand and constrained supply. They also enjoy sound cash flows and offer investors potentially attractive opportunities amid an uncertain economic future.

Find out more about Principal Asset Management

Sources