What Is Really Going On With Real Assets?

Written by: David Lebovitz

After embracing alternative investment strategies – and particularly real assets – over the better part of the past decade, the significant increase in interest rates over the last 18 months has called into question the role that these strategies play in a portfolio. While we recognize that high quality fixed income yields are now comparable to what is available in real estate and infrastructure, this is an incomplete analysis of the situation. Importantly, real assets provide a hedge against inflation, diversification and potentially a more durable source of yield than what will be available in fixed income over the longer-term. Furthermore, some of the unloved areas of these asset classes may provide investors with an opportunity for growth, particularly as valuations continue to re-rate.

Real estate valuations continue to look rich in aggregate given the move in base rates, but the more interesting story continues to be one of dispersion. While industrial sector vacancy rates ticked higher last quarter, office vacancy rates did the same, while retail and multi-family properties saw vacancy rates decline. Against this backdrop, net operating income (NOI) growth continued to normalize, and transaction volumes remained relatively stable.

As we look ahead, a few trends are evident. Leasing activity in the office space has begun to show signs of life, but only against a backdrop of rising concessions. Furthermore, 2023 has seen more office conversion activity – while sometimes this can be easier said than done, it does suggest that there is an evolving opportunity in the office space for investors who can deploy additional capital. The industrial space, meanwhile, has seen activity begin to soften, likely because valuations have steadily risen for the better part of the past few years. And looking at retail, tenant mix continues to be the key differentiator between these assets.

Infrastructure assets continue to provide investors with a combination of diversification, inflation hedge and yield. Importantly, with a slower growth environment likely on the horizon in 2024, the essential nature of these assets will once again allow them to remain resilient in the face of a more challenging macroeconomic backdrop. Most people may stop paying for discretionary goods and services if labor markets come under pressure and economic growth slows, but most individuals will continue to pay for power and water.

The investment backdrop has shifted notably over the past few years as inflation reared its ugly head, the Federal Reserve aggressively tightening monetary policy, but growth remained more resilient than many expected. The current debate is whether there will be a soft landing – the answer is that nobody truly knows. With this uncertainty hanging over investors, investments that can provide diversification, income and a hedge against the risk that inflation reaccelerates are likely worth a look.

U.S. vacancy rates by property type

Percent

Source: NCREIF,  J.P. Morgan Asset Management. All data are as of June 30, 2023. Data are based on availability as of August 30, 2023.

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