Are Real Assets Still Defensive?

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Larry Antonatos, managing director and portfolio manager, Brookfield Asset Management.

The coronavirus will have an impact on real assets and let’s talk for a moment about which real assets will be the most susceptible. In general, real assets, both real estate and infrastructure, tend to be viewed as defensive asset classes with predictable cash flows that will hold up well in economic weakness. Our expectation is that the coronavirus will cause some economic weakness. Maybe it’s an intermediate or short term weakness. It could be longer term weakness. We just don’t know how it will go. But let me tell you how the cash flows are being impacted within the real asset spaces.

If we consider one impact of coronavirus, many people are choosing not to travel. That has impact on real estate and infrastructure. Within the real estate sectors, the most impacted sectors would be the hotel sectors. Hotels have one night leases and they also have variable pricing. You don’t know whether you will rent your room and you don’t know what price you will get for that room in a very weak environment. What we’ve seen is a lot of corporations, a lot of individuals, cancelling the travel plans and that will have an impact on hotel cashflows. It may be a short term impact and things will be back to normal in three months or six months. It remains to be seen.

Currently, because we are in the early stages of the impact in the West, Europe, U.S., U.K., of the coronavirus, we are generally avoiding hotel investments today. As the worst of the coronavirus passes by and we find hotel stocks that are cheap but for which we expect the cash flows to rapidly recover, we may, at some point, aggressively add to our hotel positions to take advantage of the growing cashflows.

If we turn to infrastructure, that same travel decline is impacting the GDP sensitive transportation sectors of infrastructure. Those sectors are airports, seaports and toll roads. The impact is exactly in that order. Airports are being impacted the worst, seaports to a lesser extent as global trade declines, and toll road traffic to date has actually held up, but we would not be surprised to see that becoming more weak. Accordingly, we are avoiding significant investments in the transportation sectors. But, just as I mentioned with hotels, as the worst of the coronavirus moves past us, there may be attractive valuation opportunities in some beaten up transportation sectors that could be an opportunity for us to increase our exposures and ride the wave of growing cash flows in those assets.

Another area of infrastructure that is being impacted is oil and gas pipelines. Oil and gas pipelines do not have a direct exposure to commodity prices in general. The price of oil and gas may move up and down. That impacts the producers, the refiners, but not necessarily directly impacts the pipeline owners. The pipelines serve as toll roads to move oil and gas from point A to point B, from the point of production to the point of consumption. However, the coronavirus is leading many analysts to predict a drop in demand for crude oil in 2020. In general, historically, demand for crude oil grows almost every year and declines only in times of severe economic stress — 2020 maybe one of those years. With less demand for crude oil pipeline owners may have less crude flowing through their pipes. They may have customers who are less willing to pay big prices to move that crude oil. And despite the fact that there may be some long-term leases, long-term toll agreements, we are seeing pipeline companies in the infrastructure space being under-performers on macroeconomic weakness, just as we’re seeing the airports being underperformers.

In contrast, if I look at the areas where we’re most bullish, we would look to the most defensive sectors within real estate and infrastructure. In real estate, one measure of defensiveness is the length of the leases. We’ve already talked about one year leases for hotels versus five and 10 year leases for office buildings, but there are also categories which have even longer lease terms. One category is triple net lease. These are generally properties fully occupied, 100% occupied by a single tenant. It may be a corporate headquarters, it may be a retail location, a franchise restaurant location. Those leases, to the extent the credit quality is good and the underlying customer will survive the economic weakness, having a 20 year lease is much less risky, much more defensive, than having a one year lease for an apartment building, a one month lease for a self storage building, or a one night lease for a hotel.

Within the infrastructure space, the most defensive sectors are the monopolistic utilities. If you are the only electric utility in town, the only water utility in town, you have a significant defensive position. Whether the economy is good or bad, customers still wake up every morning, turn on their lights, brush their teeth, take a shower, and purchase the essential services provided by electric and water utilities.