Why commercial property deserves a place in an "all-weather" portfolio

Hans Lee

Livewire Markets

Warren Buffett once said that "diversification is protection against ignorance". And in a market where timing is more critical (and more challenging) than ever, many of the top money managers say it's time to look at different options for making money in this environment. For example, in the latest episode of Signal or Noise, Matthew Sherwood at Perpetual Asset Management noted the answer might be the US Dollar:

Bonds and equities are the traditional building blocks of portfolios. I think the key message to investors in this environment is you may need to do something different. Think of what other diversifiers they have in a portfolio. Gold hasn't worked this year, the yen hasn't worked, and bonds haven't worked. What has worked is the US dollar.

But is there another option to the US Dollar, a trade that is extremely overcrowded and has run very hard? Stuart Cartledge of Phoenix Portfolios argues the answer might be all around you - literally.

In this edition of Expert Insights, Stuart states the case for why he believes the commercial property sector is an "all-weather" opportunity for portfolios even if rising interest rates are crimping valuations across the board. He also nominates one company (ironically, not a REIT) that ticks all the boxes in this remarkable environment for investors.

Note: This interview was taped Wednesday, September 14th, 2022.


LW: What role does commercial property have in a portfolio right now?

Stuart Cartledge: Commercial property makes sense in a portfolio at any time in the cycle, and I'm not just saying that because we're a manager of commercial property assets. But simply the risk and reward trade-off that commercial property offers just makes for a good diversifying asset inside a balanced portfolio. 

Unless you're Einstein and can actually predict the movements of interest rates and markets and can be in the right asset at the right time which, to be honest, is extremely difficult, I would argue it has a place in a balanced portfolio through any kind of market condition.

LW: What effect do rising rates have on commercial property stocks?

Stuart Cartledge: As a starting point, rising interest rates, ultimately translating into rising bond rates, are like gravity to the apple. Every asset class, every type of asset, ultimately, has an impact through higher interest rates, and higher discount rates. Ultimately, everyone is buying an asset with the view that going to generate future returns. The value of those future returns diminishes as the discount rate that you use to discount them back to today increases. Every asset class faces a headwind with rising rates.

In commercial property, I think one of the things that people would point to as a reasonable rate rise environment or reasonable inflation environment is that you do have some protection in the form of rents that are sometimes linked to inflation. Certainly, the replacement cost of buildings is linked to inflation. If you've got rising rates, what about through inflation, which is really the situation we're describing now? There are some benefits in terms of the income that you're going to generate and also some benefits in terms of the supply side.

I think my best example - and this is stretching the boundaries of commercial real estate - but an investment in an asset like Transurban (ASX: TCL), which is a toll road owner. To me, that is commercial real estate. It just has very short leases over approximately 20 minutes at a time. But look at the tolling environment for Transurban, about 60% of their tolls are CPI-linked. 

In an environment where you've got rising inflation, an investment in Transurban is giving you some growth in the income stream. Furthermore, with Transurban, they've got a fairly well-diversified capital structure whereby the cost of interest isn't going up for a long time. You've got the best of both worlds in that situation at the moment.

LW: What are the advantages of accessing a property fund rather than single assets or stocks?

Stuart Cartledge: It's very hard for the average Joe to be able to get exposure to commercial real estate without investing in a fund, particularly if they want to have diversification. The beauty of a fund is that it does enable someone to invest in office, in industrial, in retail, in infrastructure, in property developers, and property fund managers. It's a big ticket item type asset class, and the only way to invest in that in a risk-adjusted or diversified manner is to do it via a fund.

About Cromwell Property Group

Cromwell’s property team actively manage all property assets in-house. We oversee the strategic management of all assets, ensuring that tenant requirements are met, space is leased, buildings are operating efficiently and projects are delivered on time and on budget. Click here to find out more about our products.

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Hans Lee
Senior Editor
Livewire Markets

Hans is one of Livewire's senior editors. He is the creator and moderator of Livewire's economics series "Signal or Noise". Since joining Livewire in April 2022, his interview record includes such names as Fidelity International Global CIO Andrew...

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