Private real estate and infrastructure funds around the globe have continued to expand and evolve, which has contributed to a growing acceptance and interest by institutional investors. The multi-manager fund structure can offer particular advantages by providing diversification on a portfolio level, on an asset level and through exposure to varying time horizons, investment strategies and regions.
Historically, private real estate and infrastructure funds have not generally been affected by stock market volatility to the same extent as publicly traded real estate and infrastructure companies, and returns for private funds have been more directly linked to underlying market fundamentals and manager performance. By exploiting inefficiencies in local markets, a multi-manager fund may offer a compelling option for institutional investors seeking high risk-adjusted returns from their real estate and infrastructure allocations.
Almost half of global economic growth today is due to increased demand in developing countries. In addition to this key factor, government fiscal distress, shifting demographics, deleveraging and a changing regulatory environment are key themes for global real estate and real assets today.But those themes vary across markets. Here we highlight some of them.
Americas
North America faces aging infrastructure — roads, bridges and railways — and a dearth of public financing, especially given political paralysis in Washington. That may lead to public-private partnerships, an ongoing initiative at the state level. In real estate in particular, loans taken out before the real estate bust are coming due to the
tune of $1 trillion — so there are opportunities for distressed investors. At the same time, those who invested in public real estate company recapitalizations — as companies sought to pay down massive amounts of debt — during the latter part of the financial crisis have reaped rewards and recapitalizations remain attractive.
Europe
Rental markets are stabilizing in Northern Europe, but Southern Europe remains challenged. Retail property transactions have rebounded, however. That may encourage many banks to sell property, since property prices have returned to pre-recession levels. Commercial properties are attractive, as vacancies decrease in central business districts, but on the whole tenants have the upper hand. As with the Americas, there are opportunities as governments transfer ownership of public infrastructure. In addition, a wave of loans maturing, loans financed at peak real estate values, represents opportunities.
Asia-Pacific
While Japan continues to struggle with anemic growth, rents have stabilized through the rest of the region. The fundamentals are healthy, as growing numbers of people move to the cities. In select markets, commercial tenants are moving from non-prime to prime properties. However, an absence of natural resources –leading to potential inflationary bottlenecks may crimp consumer spending, both directly and indirectly, and with it, real estate demand.
Emerging Markets
As with Asia-Pacific, emerging markets are seeing a growing middle class, with increasing disposable income. Much of this is financed by a growing trade in agricultural products. At the same time, rising energy demand could curb disposable income, and with it, the ability to pay higher rents.
Real assets as building blocks
Agriculture, water, timber, transportation and energy are the foundation of essential goods and services and offer a wide array of investment opportunities. Each contains important sub-sectors distributed along the investment risk/return spectrum. Opportunities range from inexpensive (special situations, distressed assets) to relatively expensive (income-producing) and can contribute to risk-adjusted returns in a well-diversified global portfolio.
Asia property outlook
Leasing activity in Singapore is expected to increase on rising demand for commercial property and resurgent investor confidence. During the first half of 2010, a flight-to-quality trend has been observed in the Japanese office sector as tenants have consolidated their space for only a marginal increase in rental cost. In China, rising disposable income is expected to drive increased retail spending and the retail market in China is currently underserved relative to other major global markets.
U.S. property outlook
Property markets continue to improve modestly and are beginning to show signs of stabilization. While overall valuations remain approximately 25% below the peak of 2007, values have risen approximately 20% since the trough in May 2009. With approximately $1 trillion of debt expiring in the next three years, the real estate debt markets remain a potential opportunity for investors.
European property outlook
With the first signs of increasing demand for space, according to CBRE, the European vacancy rate has remained stable over the quarter at just over 10%. The European office rental market should continue to improve, and prime rents and incentives are beginning to stabilize in the majority of markets. European commercial real estate investment turnover reached €23.5 billion in the second quarter of 2010, representing a 15% increase over the first quarter of 2010.
Why real estate and infrastructure now?
Real estate represents a large share of the investment universe and at times is characterized by inefficient pricing. The potential for strong risk-adjusted returns, often with stable cash yields, and its attributes as a hedge against inflation make it particularly compelling now. There are also large quantities of debt expiring over the coming years and increasing deal-flow activity from capital markets dislocation. In addition to a developing trend of private investment into traditional public sector assets, large capital expenditures in infrastructure as a percentage of GDP are foreseen for the next 30 years. Within a global context of varied growth and fiscal health, we believe that long-term, diversified strategies remain the key for managing downside risk protection.
Jack Foster is managing director, real estate and real assets, Franklin Templeton Institutional.