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£35B Real Estate Investor Reveals Its Stagflation Playbook


M&G Real Estate, part of M&G’s £71B private assets and alternatives division, plans to ride out stagflation with prime offices, build-to-rent residential and a smattering of hotels.

The strategy emerges from an M&G analysis that suggested the economic outlook is gloomier and more uncertain than many have so far conceded.

M&G Real Estate Head of Investment Strategy José Pellicer, speaking on Tuesday, said that inflation has shifted from being a post-Covid supply chain hangover to a “global headache” adding: “We’ve not had this kind of problem since the 1970s and '80s.”

The playbook is revealed as gloomy economic predictions begin to pile up. A surprise fall in UK GDP, revealed this week, comes as the Bank of England’s Monetary Policy Committee prepares to publish its consensus report on the likely state of the UK economy in the near term. Inflation expectations are likely to rise, with Oxford Economics predicting 10% inflation in October and a series of rate hikes across the year.

Whilst Oxford Economics think the U.S. Federal Reserve could engineer a soft landing for the economy, Moody’s Analytics Head of CRE Economics Victor Calanog predicted there is a 30% chance of a recession in 2022 and as much as 50% probability for 2023.

“Inflationary interest rate pressures will have a deeper impact on secondary assets in weaker locations, with shorter lease lengths, voids and capital expenditure required to bring them up to date, in comparison with prime assets,” Pellicer said.

“At the same time, the continuing uncertainty around the war in Ukraine and the wider political, social and economic unease it has created across the world, means that investment decisions need to be mindful of the prospect of renewed volatility and unforeseen changes in conditions.”

M&G concludes that performance on a par with 2021 will be difficult to achieve across all real estate sectors, so it is crucial that low-risk investors remove risk and create portfolios that offer long-term inflation protection. 

The response is to tilt heavily toward a small list of defensive plays in the hope that, whether central banks engineer a hard or a soft landing, the most exposed sectors of the property market are avoided.

“The real estate sector is not immune to disruption, but it is very important to realise that prime real estate will be in a much better position than secondary,” Pellicer said. “An office building in a town centre with a good EPC rating, 5 years old, you can re-let a floor because the right properties generate the right kind of tenant tension."

That triggers rental growth, which is the holy grail of today, Pellicer argued.

M&G favours properties with explicit protection against inflation, preferably with long leases, prime locations and only mild refurbishment needed. “Those are the locations where we can create tenant tension,” he said.

In the residential sector, the gamble is that higher interest rates will choke off demand for owner-occupied property and in the process boost rented homes.

The firm also has its eyes on hotels in the strongest locations.

“Consumption for leisure and tourism has remained strong, and should remain strong in 2022 and 2023, because it seems it is something people cannot do without," he said.

“None of this means value-added property is dead — there should be good opportunities to find properties at good prices — but buyers need to understand what kind of refurbishment to undertake in a period of high construction costs.”