We met with Brian Kingston, Managing Partner and Chief Executive Officer of Brookfield’s Real Estate Group and Leonie Wilkinson, Senior Vice President, Portfolio Management for Brookfield’s Real Estate assets in Australia. Brookfield is one of the world’s largest investors of real estate, with a global portfolio that includes office, retail, multi-family, and hospitality across five continents. Our panellists provided an overview of the trends they have observed in real estate over the past couple of years, what the future likely has in store as we emerge from the pandemic, and the challenges and opportunities this poses for investors. The session was moderated by Crestone Wealth Management’s Chief Investment Officer, Scott Haslem, and Senior Investment Analyst, Anshula Venkataraman.
Venkataraman explained that real assets broadly play a defensive role in client portfolios, largely because they act as the backbone of the global economy and provide stable yield. She explained that core, quality real estate assets are now playing an even more important role in investment portfolios today, predominantly as a function of the current market environment where rising rates are providing challenges for traditionally defensive assets, such as bonds. “Sectors such as corporate bonds currently present a higher correlation to equities, so we believe quality real estate assets can play a defensive role in clients’ portfolios, providing diversification and yield, and often providing some inflation protection”.
Kingston explained there has been a divergence within the property market in recent years. Certain sectors, such as industrials and logistics have benefited from the increased volume of e-commerce and online shopping and done relatively well, despite the challenges presented by COVID-19. Additionally, housing has been a beneficiary of improving consumers’ balance sheets, with people putting more capital towards where they live. On the other hand, some parts of the office, retail and hospitality sectors have been more challenged because people have been either unwilling or unable to use them through the pandemic. While high-quality assets within those sectors continue to perform well, Kingston explained that lower-quality assets have suffered. He also explained that, during the pandemic, there has been much focus on e-commerce and how it works in tandem with a ‘bricks-and-mortar’ location.
“A lot of retailers realised through the pandemic that businesses need both an online presence (where customers can engage with the brand, research products and in some cases purchase products), as well as a physical store front to pick up products and return and examine products more closely. The retailers that thrived during the pandemic are those that had a well-integrated online and bricks-and-mortar strategy”.
Prior to COVID-19, there had already been a bifurcation between high-quality, modern office buildings that met sustainability standards and older assets that were becoming functionally obsolete. Kingston explained that, as we come out of the pandemic, there is a huge focus from employers on getting people back to the office, and part of that return-to-work strategy is thinking about how they will use the office differently in the future. This includes hybrid working environments and different ways of people interacting. New, modern office buildings with wide open floorplans and a lot of functional utility are the types of office that employers are looking at. As a consequence, the value of these assets has increased, with rents rising, and the quality of the tenant occupying these buildings has also improved.
Wilkinson provided some background to the development of Brookfield Place Sydney and noted that Brookfield was able to successfully lease the building during the pandemic because it offers a highly amenitised location where employees can enjoy a range of activities through the day. She explained how tenants are now demanding the very best office accommodation for their employees.
“Offices still need to tick all the boxes they have in the past, such as a good location and sensible floorplates. However, now all the extra amenities are also becoming standard. Employers also see an opportunity for the office to be a physical manifestation of their corporate values. We have seen greater demand for assets that meet sustainability criteria. There has also been a step-up in demand for flexibility, such as increasing the amount of video-conference enabled meeting rooms, as well as flexible working space.”
Brookfield believes that with unemployment so low, this presents a tailwind for real assets generally. Wilkinson explained that global investors are currently attracted to the Australian real estate market due to its attractive income yield compared to other markets. She explained that the spread (which is the difference between the income you can earn from a real estate asset and the cost of debt on the asset) is currently around 300 basis points (bps) in the global gateway markets of Sydney and Melbourne. This compares to around 200bps in other global gateway markets. With global demand for income expected to continue as populations age and pension funds move from accumulation to retirement phase, this should underpin high demand for Australian real estate. She also explained that Australia offers investors the opportunity to invest in a transparent and highly regulated market, which also benefits from links to the Asian economy.
Wilkinson explained that Brookfield has a pathway to net-zero carbon emissions by 2050 or sooner, and that includes a focus on climate risk. She explained that they not only see it as an investment risk that needs to be managed, but also as an investment opportunity. This is reflected in the requirement from tenants for assets that meet sustainability criteria, as well as demand from capital partners.
Kingston explained that rising rates are not necessarily a bad thing for real estate. Unlike fixed income, where income is locked in for a given period, with real estate, income can be adjusted by increasing rents. He believes we are currently in a relatively benign inflationary environment, with inflation elevated due to supply-chain disruptions, and expects this should moderate over the next couple of years. “With inflation around 3-4%, long-term interest rates around a similar level, full employment and GDP growth in the 2.5-3.0% range, that’s a really attractive environment to invest in real estate. The key risk is that central banks hike rates too high, which impacts growth, and then you’re unable to pass that growth through, but we don’t think that will occur.”
Kingston explained that investors are looking for yield in this environment, particularly inflation-protected yield. Some assets, such as student accommodation, manufactured housing, multi-family apartment buildings and self-storage, have become increasingly popular with investors. This is because they benefit from relatively low amounts of capital expenditure and a high conversion from rent to cash flow.
Wilkinson explained that in Australia, both listed and unlisted property generally offer high quality management and high-quality assets. The key difference is really the volatility investors may experience through the listed market, which may be unrelated to the risk and return of the real estate investment. In the unlisted market, investors are able to be selective about where they put their capital and can generally enjoy less volatility in returns.
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