Koblavi Fiagbedzi on real estate assets and sustainable DEI workplace
Koblavi A. Fiagbedzi
MBA, CFA, CAIA
CBC Pension Plan
In the rising inflation environment, institutional investors increasingly allocate towards real assets such as real estate for portfolio diversification and yields. How are real estate sectors shifting and what should investors consider when approaching real estate portfolios?
Institutional CONNECT: Given concerns of rising inflation rates on valuations, does real estate offer adequate inflation protection in the current environment?
Real estate is indeed widely considered to be a great store of value. Unlike previous cycles, I think that the inflation protection conferred onto investors will be a direct result of their asset selection and portfolio construction decision. This is in stark contrast to the historical experience. Inflation protection in the past was essentially “gifted” to any investor with real estate interests; during this time, returns differences between the office, retail, multifamily and industrial sectors were largely muted. Sectoral returns gyrated in sync with one another and were supported by highly visible and positive demand fundamentals in the long run. Times seem quite different now. Over the past seven years, real estate sector risks and returns have diverged due to differing demand drivers and investor appetite. Forward looking NOI growth estimates across the two large segments of a typical institutional investor’s portfolio, core office and core retail, are likely to be staid or negative. Declining property cashflows and structurally weaker demand in these two segments may pose a challenge to sustainable inflation protection at the asset level.
On the other hand, multifamily and industrials are likely to continue to have tailwinds that are supportive of stronger absorption rates, leasing velocity, and rental growth over the medium term. We adopted a significant overweight posture of 65% to these two segments precisely because of such tailwinds. Indeed, multifamily and industrial rents often have very direct linkages to inflation, and upon tenant turnover, can be re-leased at prevailing rents rather quickly. Currently, these market rents are substantially higher than sitting rents due to historically low vacancy. In addition to sector weights, attributes such as overall portfolio duration, loss to lease cushions, embedded inflation betas, liquidity, and lease types matter. Optimization of these attributes will likely amplify the velocity of inflation passthrough for investors. Alternative real estate sectors seem to hint at some degree of inflation protection too. The necessary caveat here is that the historical record is far too short to be empirically conclusive on this point.
Koblavi: Significant commentary has been devoted to return concentration in the S&P 500 amongst FAANG and similar stocks. Well, the real estate equivalence of this is in the multifamily and industrial sectors where over 70% of total returns have been recently concentrated. Unlike the FAANG stocks in terms of market cap, however, they are in the smallest investable areas of the real estate market when compared to the much larger office and retail segments and vigorously contested for. Given return concentration, investors are rightly assessing the inclusion of alternative real estate sectors to further diversify portfolios and improve their batting average with regards to sector allocation decisions. Whilst alternative sectors comprise over 50% of exposure for a number of global REITs, their weight in institutional private market portfolios, though growing, is considerably smaller. Manufactured housing, single family rentals, life sciences, student housing, data centers, NNN leases, and self storage are just some of the sectors that have gained prominence in recent years in private market portfolios.
From a fundamentals perspective, some of these sectors possess the very attributes investors look for in more traditional sectors: high absorption rates, lease velocity, low turnover, stable occupancy, long lease terms, capex visibility and scale. Taken together, this allows for aggregation, operationalization, and greater levels of institutional ownership in a space that is otherwise highly fragmented and subject to barriers to entry. For example, self storage and manufactured housing appear to show cycle resilience and a record of consistent NOI growth. In the lower octane segment, NNN leases can be both a complement to very core positions and source of additional industrial exposure. Manufactured housing may also serve as another channel to address housing affordability and household space needs as a complement to multifamily sector exposure. I think over the coming years, alternative sectors will become a material component of an investor’s portfolios fuelled by maturity in the industrial sector and moderation of office and retail exposure. Prudent exposure to alternative sectors may also give Portfolio Managers more tools to optimize weighted average cap rates, yields, tenant base and type, and capital growth factors at the portfolio level to help deliver the pension promise.
Koblavi: I think DEI needs to first start with a solid foundation of Equity and Inclusion in an organization. That is “E-I”, and then “D”, with each letter in the necessary order to better support diversity goals. A culture and workplace that is competency based, meritocratic and actively seeks and embraces diverse viewpoints is naturally fertile ground for a broader Diversity emphasis.
To increase chances of successful execution of the “D”, I think leaders need to: (1) clearly articulate their definition of diversity and the “why” behind the organization’s approach; (2) personally embody the corporate DEI vision; and, (3) be fully engaged across all points of the long journey. Development of strategies to address diversity gaps must be holistic and curated to the needs of the organization, but only after a careful study of existing organizational shortfalls. As an example, what may be beneficial from a gender lens, such as networking/mentoring opportunities, leave provisions, and flexible work hours, etc. may not adequately address the needs of visible minorities who may face other barriers from a recruitment or retention perspective. A great source of information and direction, as a first step, is often current employees who are aware of existing shortfalls and possible solutions to address them. Successful execution of strategies will likely be long-lived and self-reinforcing when codified as part of corporate policies, procedures, and norms. Critically, these strategies, and the impact of them, should be regularly assessed and adjusted or calibrated for additional impact when necessary. Tools to support HR, Managers and Staff should be made readily available and employees empowered to move the needle and be agents of change.
I believe that there are also things that the DEI model is not about that is worth addressing. DEI is not about fixing the proverbial race to artificially support certain groups at the expense of another, a call for corporate largess, or the codification of rent seeking behaviour. I think at the heart of the DEI model is education, genuine introspection and human allyship in a safe space; we are all in this together! This acknowledgment allows each of us to better engaged to undertake the hard restorative work to open up the race to all participants who want to run it.
DEI= More Opportunities For Everyone.