Module 3
Alternative asset classes: real estate & infrastructure
Welcome to Module 3. You are almost halfway through your journey to becoming an Alts Guru. This module contains the final type of asset class — real assets and we will focus on real estate and infrastructure.
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What are real asset funds?
It is time to shift gears. Real asset funds are backed by physical assets and have an intrinsic worth due to their substance and property, such as infrastructure, real estate and commodities. These solutions can be found in both public and private markets and provide opportunities for portfolio diversification, income streams, and inflation hedges.
Let’s commence: real estate
Introduction to real estate
The most common real estate sectors include office, residential, industrial & logistics and retail. There are numerous other secondary sectors including hospitality, self-storage, student accommodation, retirement and other special purpose buildings.
An investor would typically invest in real estate through either of the following primary markets:
- Public markets (Real Estate Investment Trusts or REITs listed on public exchanges)
- Private markets (Equity or Debt Funds)
Real estate investment strategies can be influenced by trends including:
- Demographics and population growth
- Urbanization
- Changing consumer behaviours (physical > online shopping)
- Sustainability and ESG factors
- Infrastructure investment
Investing in real estate is attractive due to the stability and predictability of the cashflow it can provide (relative to other asset classes) and long term potential capital growth opportunities. Real estate also has a low and sometimes negative correlation with other assets class returns and can therefore be a good way of creating diversification across an investment portfolio.
Guru glossary – what is the risk return spectrum?
The risk–return spectrum is the relationship between the amount of return gained on an investment and the amount of risk undertaken in that investment. The more return sought, the more risk that must be undertaken.
Did you know?
That two thirds of global net worth is stored in the real estate market. 1
Real estate investment strategies
There is a broad range of real estate investment strategies available. Which strategy to choose (or combination of strategies) really depends on an investor’s appetite for risk and return.
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A Core real estate fund invests mainly in income producing existing buildings. The fund will use low leverage, have no or very low development exposure and generate a high proportion of return through income. Tenants in these buildings are typically corporate or institutions with strong credit ratings. Lease terms are also typically 5 years or more, which provide income certainty.
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A ‘Core Plus’ real estate fund can provide a combination of both ‘growth and income’ and is associated with a low to moderate risk profile. Core plus property owners typically have the ability to increase cash flows through light capital works programs to enhance the asset appearance, introducing management efficiencies to reduce operating costs or by increasing the quality of the tenants and rental income. Similar to core properties, these properties tend to be of high-quality and well-occupied.
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A value add real estate fund may invest in any property type and aims to generate returns from a balance of rental income and capital appreciation. The fund may allocate part of its investments into development projects. Typically, the fund will also focus on actively managing the property and the property’s income stream such leasing vacant space to reduce occupancy, repositioning or redeveloping the layout to make it more attractive to tenants and therefore increase rent. The fund will use moderate leverage.
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An opportunistic real estate fund typically uses high leverage, has a high exposure to development or existing buildings which require active asset management. The fund will aim to deliver returns primarily in the form of capital appreciation. The fund may invest in any markets or sectors, and may be highly focused on individual markets or property types.
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A mezzanine debt fund is a type of subordinated financing used to increase leverage in a commercial real estate transaction. In order of priority, mezzanine debt typically sits in between common equity and senior debt within the capital stack and will have priority of repayment over the common equity, but is repaid only after the senior debt has been repaid. It is therefore higher risk than senior debt and attracts a higher return premium.
Similar to senior debt, mezzanine loans have fixed or floating interest rates and set maturity dates. Some other features of mezzanine debt include higher interest rates than senior debt; may be secured by a pledge of interest in the property ownership entity; and typically less risky than common equity due to collateral.
Public REITs
A public real estate investment trust (REIT) is an entity that owns, operates or finances properties that produce income in a particular sector of the real estate market.
Investors can buy publicly traded shares in a REIT or a REIT fund listed on major stock exchanges.
REITs can also be private or non-publicly-traded and can be accessed by certain investors through private market brokers or investment management companies. Due to their non-public status, private REITs typically make less frequent distributions to investors and are therefore known as less liquid than public REITs which can be traded daily.
Guru glossary – what is loan-to-value?
The loan-to-value (LTV) ratio is an assessment of lending risk that financial institutions and other lenders examine before approving a mortgage. The LTV is typically calculated by dividing the amount of money being borrowed by the lender by the value of the property used to secure the loan.
Moving on: infrastructure
What are infrastructure strategies?
Infrastructure is the basic system that undergirds the structure of any country’s economy - it covers a wide range of different sectors, including energy, transport, communication networks, water and waste, and social infrastructure. Infrastructure is a central element in all aspects of economic and social activities, and is essential for the quality of life, the green transition and successful sustainable development.
Historically, governments around the world have funded these investments, however over the past fewer decades, the public sector has played a critical role on helping close the infrastructure-funding gap, allowing infrastructure itself emerge as an asset class. While significant progress has been made, the current global infrastructure investment still falls well short of what is needed. It is estimated that the world needs to invest an additional $13 trillion to provide adequate global infrastructure by 2050.
Infrastructure fund investment strategies
Investors are drawn to infrastructure due to its stable and predictable cash flows with limited downside risk and effective built-in inflation protection mechanism.
Depending on the investor’s desired outcome, with infrastructure, there are many strategies across the risk-return spectrum: investment grade, high-yield / mezzanine, core, core plus, value add, and opportunistic.
The macro trends shaping our world
We invest in three high-conviction, structural themes in infrastructure – which we call the 3Ds. At BlackRock, these mega forces will drive the opportunity set for many decades to come – resulting in an estimated $100 trillion investment opportunity:
Extra credit: keeping up with inflation
A macroeconomic risk that every investor is worried about at the moment is the possibility of higher inflation. The evidence of infrastructure’s inflation hedge characteristics is strong. Historical data shows that infrastructure has performed better than other asset classes – such as listed equity and bonds - when inflation is high.
Test your knowledge
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