Investing in real assets amid banking turmoil

The collapse of Silicon Valley Bank sent shockwaves through the financial industry, prompting banks to prioritize stronger balance sheets and increasing the risk of recession.

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While stricter lending standards could allow central banks to pause rate hikes sooner than expected, Larry Antonatos, managing director and portfolio manager with Brookfield Asset Management, said the increased financial scrutiny could heighten the risk of a recession. 

Against this backdrop, Antonatos said investors should consider how different infrastructure and real estate sectors are likely to perform. While some sectors are more vulnerable to a downturn, he said others are safer places to invest as growth slows. 

“Relative to many traditional investment sectors, infrastructure and real estate offer more predictable revenues and predictable cash flows,” Antonatos said. In real estate, predictable revenues are a result of long-term leases; in infrastructure, revenues are driven by regulated pricing and limited competition.

Consequently, in a shallow recession, Antonatos said both real estate and infrastructure should outperform traditional cyclical sectors. Broadly speaking, infrastructure is typically more defensive than real estate, Antonatos said.

“Real estate is generally a free-market business driven by the traditional interplay of supply, demand and pricing,” he said. “In contrast, infrastructure is generally a regulated business where regulation can significantly impact supply and pricing.”

For example, the real estate rental rate can be volatile and impacted by supply and demand at the time of negotiation. Conversely, infrastructure provides essential services, so demand is generally steady.

Sub-sectors in both real estate and infrastructure range in their sensitivities to economic growth, creating “more granular investment opportunities,” Antonatos said. 

Within real estate, growth sensitivity is higher for property types with shorter lease durations, such as hotels, and sectors tied to consumer spending, such as retail. Growth sensitivity is lower for property types with longer lease durations, such as industrial and office.

Within infrastructure, growth sensitivity is higher in the transport sectors — namely airports, seaports and toll roads — because of their sensitivity to volume, Antonatos said. Conversely, utilities and communications tend to have steady demand and are therefore more attractive investments in a recessionary environment. 

In addition to navigating what Antonatos expects will be a “short and shallow recession,” real estate investors are also dealing with three longer-term trends.

First, Antonatos said he expects working from home will become a supplement to — rather than a substitute for — the office. 

“While remote work can provide flexibility for employees, office work allows for collaboration, connection and culture, essential ingredients for enterprise growth, risk management and employee development,” Antonatos said. These are particularly important for newer and younger employees, he added.

Second, he expects the pandemic to reverse the office densification trend of the past few decades. Office square footage per employee decreased from 425 square feet in 1990 to 150 square feet per employee in 2020, Antonatos said. A reversal of that trend will lead to an increase in demand for office space.

Third, he expects major cities will continue to attract talent. “Urbanization has been a powerful trend for centuries for one simple reason: commerce and culture thrive in the vibrancy of a great city,” he said. 

Major markets will continue to be important for global companies, transaction-oriented businesses and creative industries “where in-person contact is critical,” he said, citing Toronto, New York and London as examples of important office markets. 

Some smaller markets will also be able to attract jobs and talent due to better quality of life, such as good schools, easier commutes or lower taxes, he said, pointing to the “success stories” of  Austin, Texas and Nashville, Tennessee.

In all markets, Antonatos said demand for the highest-quality property will get stronger, while lesser-quality property becomes less desirable and possibly even obsolete. Modern, well-located and amenity-rich office environments will help employers attract top talent.

“In the short run, the return of the workplace may be slow, but in the long run we believe Class A in major markets is essential to business and will be resilient,” he said. 

Conversely, Antonatos said the continued rise of e-commerce will likely lead to a permanent drop in demand for retail space, and he believes the pain will be greatest in the middle market. 

Top-quality retail will benefit from high sales per square foot, driven by dense population and high-income areas, he said, while convenience retail, such as grocery and drug, will remain consistent because they are necessity driven. 

“It is the middle-market properties which may suffer,” he said. If they do survive, he said many will be repurposed to other uses such as multi-family housing or self-storage. 

The fallout from Silicon Valley Bank may also affect smaller real estate companies. Regional banks are important sources of capital for small and mid-size commercial real estate properties, Antonatos said, so stricter lending standards may reduce their access to capital and lead them to the commercial mortgage-backed securities market.

“We believe that publicly traded real estate companies will be less impacted by the fallout from Silicon Valley Bank,” he said.

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