Profiting from property in times of inflation uncertainty

June 09, 2022

Profiting from property in times of inflation uncertainty

THOUGHT LEADERSHIP BY CRAIG SWANGER

 

Inflation is not a problem for investment markets. Inflation uncertainty, on the other hand, creates volatility as investors get nervous about profit margins, particularly for equities.

 

Fortunately for savvy investors, volatility creates opportunity. While many investors will sell growth assets and rush to cash, smart investors know there are some assets that offer opportunity amidst the chaos.

 

The two most significant opportunities for investors are real estate and corporate bonds (we’ll cover corporate bonds opportunities another time).

 

Real estate

 

The post-pandemic environment, much like the post-GFC environment, presents an ideal market for property investors. But more than any other asset class, property investment returns are driven by asset selection; MSCI research found that asset selection in real estate accounted for 78% of return variance in crisis periods.

 

Stoic’s view of where the best opportunities could be in the current market (and areas to perhaps avoid) are provided in the following summary, with important thematics driving property returns over the next few years being:

 

  1. Geopolitical risk: which is worsening the already fragile economic environment in the EU and UK.
  2. Post-pandemic social-work changes: Work from home is becoming a permanent change for millions of people, creating property opportunities in non-CBD locations particularly in accommodation, healthcare, retail and industrial; but also creating risks for CBD locations in the same sub-sectors.

 

More on each of these themes and opportunities

 

Theme

Investment Opportunities

Work From Home

The pandemic accelerated the work from home trend by an estimated 5 years. Office rents in CBD locations in the world’s largest 20 office markets fell by an average of 9.3%, and vacancies rose by 18% between 2020 and 2021 (CBRE), with only Shanghai seeing falling vacancies in 2021 (although that will be threatened by the fallout from the current extended lockdown).

Most data supports a decline of 10-15% in CBD office demand

 

In Australia, the ABS survey showed that work from home had reduced the demand for 350,000 office desks, implying reduced lease demand of 3.5 square metres, 13.5% of office space nationally.

 

Global property design experts, Arup, surveyed office workers and found an expected increase in days worked from home - from 0.65/wk to 1.71/wk - implying a 12-15% reduction in office space demand, assuming that extra work from home time is not spread evenly.

 

Office occupancy (ie how many desks are being utilised) rates have been very slow to rebound, showing a pattern after each lockdown that would also indicate a “new normal” of around 80-90% of the pre-Covid occupancy, again implying 10-20% decline in long-term demand.

 

 

 

Flexible, sustainable office environments in shorter commute locations, and smaller cities

Flexible office assets are critical as a massive 87% of corporates surveyed by CBRE were embracing “hybrid” office environments. These have previously traded on higher yields than CBD locations, but this gap could close considerably, creating one-off profit opportunities for investors.

With 60% of all office rental income tied to leases releasing in the next five years, office assets without this flexibility could see a 40% erosion in rental income by 2025 according to MSCI.

All Property Sub-classes in desirable regional locations

 

Housing affordability and work from home trends have combined to see a significant rise in property valuations for office, retail, specialist and hotel assets in cities with more desirable lifestyle locations. In Australia, top performing markets include South East Queensland, Newcastle and Wollongong, Victoria’s Surf Coast, Tweed and Byron-Ballina.

In the US, New York, LA, San Francisco and Chicago have collectively lost one million people to cities like Phoenix, Houston, Tampa and Las Vegas.

 

What’s more interesting for property investors is that the wealthier are the more likely to move as shown in the data below from the US IRS and Postal Service. It shows that around 80% of the net outflows from New York have been from the highest 20% of the population. Similar trends are clear in Australia, where high value beachside locations such as the Sunshine Coast, Byron and Mornington have been the largest migration beneficiaries in the past two years. This has significant implications for accommodation, healthcare, retail and eCommerce logistics property in particular.

 

 

The Great Migration

In Australia, the US and Canada, there has been a long-term gradual shift out of major cities into regional cities with more affordable housing, better access to schools and a better, cleaner lifestyle. That trend accelerated rapidly during the pandemic and has continued into 2022.

 

Retail property: Regional with major anchors

Retail property in CBD locations will lose share of total consumer spend, creating relative opportunities in regional retail locations. Shopping centres with major grocery anchor tenants, particularly destination tenants such as supermarkets, long WALE, and capacity to expand/upgrade are attractive assets.

 

Compression in spread between regional and urban asset cap rates

This increased mobility, work from home and the Great Migration, all leads to changing demand for regional property assets relative to urban centres. Residential prices, always the first to respond, show record increases in prices. Industrial assets have been quick to follow as small industrial parks around these regional locations fill up and demand for ecommerce distribution hubs explodes.

eCommerce distribution hubs

 

This rapid, unplanned shift out of the major cities will drive demand for consumer spending-related assets, namely retail shopping centres (see above) and distribution centres.

 

Supply will be slow to respond, creating increased rental income at the same time as falling cap rates. This creates opportunities for investors if they can find strongly positioned assets in these growth locations, particularly in coastal locations in Australia.

Regional specialist assets: healthcare and hotels

Similarly with specialist assets – cap rate differentials between urban and regional locations will compress, creating opportunities to profit from regional assets. Hotel/ accommodation assets will benefit from the expected boom from domestic tourism as travellers avoid international travel, and as regional cities grow in population.

 

 

 

Any financial product advice in this document is general in nature. It does not take into account your needs, financial situation or objectives. Before acting on the advice, you should consider whether it is appropriate to you in light of your needs, financial situation and objectives. Also, past performance is not a reliable indicator of future performance.

 



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