• Real Assets
  • Real Assets
  • Real Estate

Illiquidity premia in real assets: Q2 2022

Our real assets research team crunch the data to see whether the effects of rising inflation and interest rates are being reflected in private market returns.

Read this article to understand:

  • How the effects of macroeconomic factors on real assets varies by sector and transaction type
  • Why long-income real estate is demonstrating resilience in the high-inflation environment
  • Why forced selling could present opportunities in the asset-backed securities market

Figure 1: Illiquidity premia in private markets

Illiquidity premia in private markets

Note: Illiquidity premium required for private real estate equity transactions reflects the time it takes to sell and achieve a fair value. Indicative time period: 3 months.
Source: ICE BoA Merrill Lynch, Bloomberg, Aviva Investors. Data as of June 30, 2022

Historically, illiquidity premia in real asset markets have been compressed during market downturns, with private debt generally repricing at a slower rate than public market equivalents. On the other hand, they are often at their widest in the aftermath of a recession, as public markets rebound faster while private market investors maintain their discipline over a longer period. 

Our latest data suggests that, while there has been some compression in illiquidity premia over the last quarter, this varies by sector and the specific nature of a transaction. For example, in infrastructure debt, private spreads have remained stable during a period when public spreads have widened significantly, causing the illiquidity premium to decline.

While a fall in average illiquidity premia remains applicable to real estate finance, long-income real estate and private corporate debt, illiquidity premia have varied at a transaction level. Overall, given the time lag associated with changes in public markets being reflected in private markets, it remains to be seen how soon private market pricing will reflect public market volatility.

Given that illiquidity premia vary by sector, identifying appropriate liquid benchmarks is key in enabling cross-sector comparison. Due to this differentiation, broad public benchmarks can be misleading. We assess illiquidity premia by analysing sectors on a comparable basis, using liquid benchmarks appropriate for each asset class.

Real estate debt

Within real estate, liquidity remains steady in debt and equity, though the approach among lenders has become more cautious.

Sectors previously out of favour have seen less of a pricing impact

Pricing has moved outwards, although not yet significantly. Sectors previously out of favour, such as retail, have seen less of a pricing impact, but there has been a cooling in sentiment towards better-performing sectors, such as logistics.

Overall, there is widespread uncertainty given the inflationary environment. The impact is likely to vary between different sectors.

Real estate long income

Investors continue to see the benefit of long-lease real estate let to investment-grade companies and public sector counterparties, with secure contractual cashflows rising with inflation. While they present greater risk, assets tied to sub-investment grade covenants look attractive on an opportunistic basis.

Higher demand in the healthcare and student accommodation sectors continue to sharpen pricing in these sectors

Despite the recent steep rise in construction costs, forward-funding structures remain attractive as raw material prices are expected to gradually stabilise. Higher demand in the healthcare and student accommodation sectors, combined with low stock and significant gilt volatility, continues to sharpen pricing.

Over the next year, we expect to see margins and illiquidity premia restored, as investors become more price-sensitive given rising gilt yields.

Infrastructure debt

Investment activity in the infrastructure market is likely to maintain a strong focus on renewable energy and digital infrastructure, such as fibre broadband. Progress is also being made to develop business models for sectors such as carbon capture and storage, hydrogen and nuclear energy. With the most recent contract-for-difference auction for offshore wind taking place in July, the focus now is delivering tangible progress towards net zero.

Inflation-linked assets will likely be impacted more positively

While inflation presents a real risk, its impact on infrastructure is mixed. Inflation-linked assets will likely be impacted more positively, with the significant rise in energy costs also benefiting assets exposed to prevailing power prices.

In markets such as green energy, excess liquidity is beginning to depress pricing. Public spreads have widened but private spreads remain stable. Time will tell whether private market pricing will start to reflect pressures in public markets.

Structured finance and private corporate debt

The market for private placements continues to present strong relative value, with a significant increase in investment activity and rising spreads. Conversely, market uncertainty has resulted in the relative unattractiveness of mid-market opportunities within the sub-investment grade universe.

Opportunities appear more attractive in floating-rate loans

While non-cyclical and defensive sectors may remain resilient, selectivity is critical. With lending costs rising, export credit agency financing continues to be competitively priced. Opportunities appear more attractive in floating-rate loans given the rise in rates. We also see significant value in asset-backed securities as spreads widen, with forced sellers needing to cover collateral costs.

Key risks

Investment risk

The value of an investment and any income from it can go down as well as up and can fluctuate in response to changes in currency and exchange rates. Investors may not get back the original amount invested.

Illiquidity risk

Where funds are invested in real estate / infrastructure and illiquid private assets, you may not be able to switch or cash in your investment when you want because real estate in the fund may not always be readily saleable. If this is the case we may defer your request to switch or cash in your units.

Valuation risk

Investors should bear in mind that the valuation of real estate / infrastructure is generally a matter of valuers’ opinion rather than fact.

Related views

Important information

THIS IS A MARKETING COMMUNICATION

Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (AIGSL). Unless stated otherwise any views and opinions are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Information contained herein has been obtained from sources believed to be reliable, but has not been independently verified by Aviva Investors and is not guaranteed to be accurate. Past performance is not a guide to the future. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Nothing in this material, including any references to specific securities, assets classes and financial markets is intended to or should be construed as advice or recommendations of any nature. Some data shown are hypothetical or projected and may not come to pass as stated due to changes in market conditions and are not guarantees of future outcomes. This material is not a recommendation to sell or purchase any investment.

The information contained herein is for general guidance only. It is the responsibility of any person or persons in possession of this information to inform themselves of, and to observe, all applicable laws and regulations of any relevant jurisdiction. The information contained herein does not constitute an offer or solicitation to any person in any jurisdiction in which such offer or solicitation is not authorised or to any person to whom it would be unlawful to make such offer or solicitation.

In Europe, this document is issued by Aviva Investors Luxembourg S.A. Registered Office: 2 rue du Fort Bourbon, 1st Floor, 1249 Luxembourg. Supervised by Commission de Surveillance du Secteur Financier. An Aviva company. In the UK, this document is by Aviva Investors Global Services Limited. Registered in England No. 1151805. Registered Office: 80 Fenchurch Street, London, EC3M 4AE. Authorised and regulated by the Financial Conduct Authority. Firm Reference No. 119178. In Switzerland, this document is issued by Aviva Investors Schweiz GmbH.

In Singapore, this material is being circulated by way of an arrangement with Aviva Investors Asia Pte. Limited (AIAPL) for distribution to institutional investors only. Please note that AIAPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIAPL in respect of any matters arising from, or in connection with, this material. AIAPL, a company incorporated under the laws of Singapore with registration number 200813519W, holds a valid Capital Markets Services Licence to carry out fund management activities issued under the Securities and Futures Act (Singapore Statute Cap. 289) and Asian Exempt Financial Adviser for the purposes of the Financial Advisers Act (Singapore Statute Cap.110). Registered Office: 138 Market Street, #05-01 CapitaGreen, Singapore 048946.

In Australia, this material is being circulated by way of an arrangement with Aviva Investors Pacific Pty Ltd (AIPPL) for distribution to wholesale investors only. Please note that AIPPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIPPL in respect of any matters arising from, or in connection with, this material. AIPPL, a company incorporated under the laws of Australia with Australian Business No. 87 153 200 278 and Australian Company No. 153 200 278, holds an Australian Financial Services License (AFSL 411458) issued by the Australian Securities and Investments Commission. Business address: Level 27, 101 Collins Street, Melbourne, VIC 3000, Australia.

The name “Aviva Investors” as used in this material refers to the global organization of affiliated asset management businesses operating under the Aviva Investors name. Each Aviva investors’ affiliate is a subsidiary of Aviva plc, a publicly- traded multi-national financial services company headquartered in the United Kingdom.

Aviva Investors Canada, Inc. (“AIC”) is located in Toronto and is based within the North American region of the global organization of affiliated asset management businesses operating under the Aviva Investors name. AIC is registered with the Ontario Securities Commission as a commodity trading manager, exempt market dealer, portfolio manager and investment fund manager. AIC is also registered as an exempt market dealer and portfolio manager in each province of Canada and may also be registered as an investment fund manager in certain other applicable provinces.

Aviva Investors Americas LLC is a federally registered investment advisor with the U.S. Securities and Exchange Commission. Aviva Investors Americas is also a commodity trading advisor (“CTA”) registered with the Commodity Futures Trading Commission (“CFTC”) and is a member of the National Futures Association (“NFA”). AIA’s Form ADV Part 2A, which provides background information about the firm and its business practices, is available upon written request to: Compliance Department, 225 West Wacker Drive, Suite 2250, Chicago, IL 60606.