The outlook for real estate

20 Jun 2022

The effects of the COVID-19 pandemic have been far-reaching across all industries, changing habits that have affected demand for real estate assets. Between the rise of remote work and a surge in e-commerce, over the past two years, commercial real estate has recalibrated to reflect fundamental changes in our way of life, creating opportunities in some sectors and challenges in others.  

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.

What role does real estate play in investment portfolios?

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”.

How have the different sectors performed through the pandemic?

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”.

What is Brookfield’s outlook for the office sector?

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.”

What is the outlook for Australian real estate compared to the global market?

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.

How does Brookfield approach asset resiliency vis-à-vis climate change risk?

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. 

How is Brookfield navigating an environment of rising inflation and interest rates?

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.”

Which other sectors in real estate look attractive?

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.

Why invest in unlisted property versus listed?

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.  

Important note

This article has been prepared by Crestone Wealth Management Limited (ABN 50 005 311 937, AFS Licence No. 231127) (Crestone Wealth Management). The information contained in this document is of a general nature and is provided for information purposes only. It is not intended to constitute advice, nor to influence a person in making a decision in relation to any financial product. To the extent that advice is provided in this document, it is general advice only and has been prepared without taking into account your objectives, financial situation or needs (your Personal Circumstances). Before acting on any such general advice, we recommend that you obtain professional advice and consider the appropriateness of the advice having regard to your Personal Circumstances. If the advice relates to the acquisition, or possible acquisition of a financial product, you should obtain and consider a Product Disclosure Statement (PDS) or other disclosure document relating to the financial product before making any decision about whether to acquire it.

Although the information and opinions contained in this document are based on sources we believe to be reliable, to the extent permitted by law, Crestone Wealth Management and its associated entities do not warrant, represent or guarantee, expressly or impliedly, that the information contained in this document is accurate, complete, reliable or current. The information is subject to change without notice and we are under no obligation to update it. Past performance is not a reliable indicator of future performance. If you intend to rely on the information, you should independently verify and assess the accuracy and completeness and obtain professional advice regarding its suitability for your Personal Circumstances.

Crestone Wealth Management, its associated entities, and any of its or their officers, employees and agents (Crestone Group) may receive commissions and distribution fees relating to any financial products referred to in this document. The Crestone Group may also hold, or have held, interests in any such financial products and may at any time make purchases or sales in them as principal or agent. The Crestone Group may have, or may have had in the past, a relationship with the issuers of financial products referred to in this document. To the extent possible, the Crestone Group accepts no liability for any loss or damage relating to any use or reliance on the information in this document.

This document has been authorised for distribution in Australia only. It is intended for the use of Crestone Wealth Management clients and may not be distributed or reproduced without consent. © Crestone Wealth Management Limited 2022.