As interest rates continue to grind higher, and inflation remains sticky, what role does the listed real asset sector play for investors targeting income? The key to answering this question lies in the potential for real returns. Real asset business models often benefit from inflation linkage and growing income streams, driving the potential for real returns.
The sector generally benefits from defensive long-term contractual income streams paid by high quality counterparties reducing economic sensitivity and improving cashflow visibility.
In the public markets, investors are increasingly seeking to price sustainability risks of their investments by considering the environmental impact of business decisions and the carbon footprint of assets. A growing regulatory burden is creating risks and opportunities that will only become more financially material in the years ahead. Undertaken properly, sustainability considerations are also shedding light on the lost income streams as obsolescence or stranded asset risks arise. Buy and sell side analysts, as well as company management teams, are increasingly forecasting and “guiding” the capital expenditures required to “green” their assets. In certain real assets sectors, these costs are higher than others and navigating through these pressures ultimately determines a company’s ability to grow its dividends and the value of its investments over time.
In the context of infrastructure increased capex requirements, repurposing costs or even stranded asset risks are foreseeable in those assets that support the generation, storage or transportation of fossil fuel related energy. Within real estate subsectors, environmentally driven capex risks are particularly acute where the stock of assets is older, predominantly seen in retail and offices. These sectors continue to see diminishing pricing power and a higher cost of capital, impacting their ability to drive income and ultimately dividend growth for investors. For bargain hunters these areas remain a potential value trap, while quality investors watch closely from the sidelines as threats of dividend cuts loom.
In the face of these risks, opportunities remain in sectors such as renewable energy infrastructure. Policy measures including the Inflation Reduction Act (“IRA”) and the European Union’s “Fit for 55” provide a strong runway for investments across the sector through tax incentivization and subsidy regimes. On the demand side, corporate awareness, net zero goals and preferences are driving willingness to enter into above market off-take arrangements or long-term power purchase agreements, providing visibility of cash flow to asset owners and developers. Despite the decline in power prices over the shorter term and higher cost of capital, companies in this sector benefit from relatively lower cost of debt and remain on track to increase their dividends given the contracted, often inflation-linked, income they generate.
Within the real estate, the growing trends of re/near-shoring, data storage and ageing demographics also present significant opportunities for real estate investors across logistics, data centers and healthcare sectors. Tenants in these cases tend to be the better capitalized structural winners in economies or even supported by governments. Furthermore, as the replacement cost of buildings has increased due to inflationary pressures, landlords maintain pricing power and the ability to ask for higher rents as supply remains limited. Real estate businesses that have embedded sustainability considerations within their investment processes are also seeing lower capex burdens and have been more astute in recycling their portfolios towards higher quality assets.
