We define real assets as physical or hard assets with economic utility which can generate income streams with the potential to grow over time. These characteristics generally provide a long-term hedge against inflation, although unlike inflation-linked bonds, this linkage is tenuous over shorter time frames. The core of a real assets portfolio is typically focused on commercial and residential real estate, but a broader definition includes (a) natural resources such as farmland, timberland, energy and mining investments (b) infrastructure assets such as transportation, power, energy and other utilities, and (c) fungible assets such as airplanes, railcars, ships and equipment. Physical commodities are hard assets but are not attractive in a multi-asset class portfolio given their lack of income generation.
Investors typically categorizes real estate strategies into core (high quality assets with stable long-term income yields), value-add (assets with the potential to enhance value through leasing up vacant space or modest repositioning) and opportunistic (strategies offering the highest returns such as development, change of use, or substantial redevelopment / repositioning). A similar framework can be used for most categories of real assets.
Finally, it is worth noting that the inclusion of real assets in portfolios is especially compelling for US taxpayers who enjoy significant tax advantages.
How we invest
We prefer value-added and opportunistic strategies where skilled investors and operators can deliver greater total return potential over the long term. Our real estate managers seek to acquire assets at a discount to fair market valuations, improve the quality and income profile of the asset, and thus enhance the long-term value of the asset. The real estate market is still highly fragmented and inefficient, and thus we are biased towards smaller managers who fly below the radar of institutional competition and sector specialists who have exceptional sourcing and operating expertise.
Through a US real estate manager, we co-invested in a multifamily residential property in Texas with c.1,200 units. The asset was acquired off-market at an estimated 30% discount to replacement cost. The asset was generating stable cash flows and, as a result, our partner could secure attractive financing at a loan-to-cost of 75% which translated into an initial cash-on-cash yield of 12% with upside to be derived from straightforward renovations supporting rent increases. At the time of underwriting, the asset was expected to deliver a high teens IRR, but we are currently forecasting a 35-40% IRR as a result of stronger than expected operating performance and market tailwinds.