PAT Cast #11: 2023 Outlook - Looking through the uncertainty

31 / 01 / 23 - 23 minute read

Shock interest rate rises, spiralling food and energy prices and political headwinds - 2022 was a challenging and turbulent year.

But when considering the impact these shocks had on real asset investment strategies, we’re asking,‘do things look better for 2023’?

In this episode we get exclusive insight from two of PATRIZIA’s most prominent investment strategists. We learn about the coming challenges in 2023 and their implications on real assets over the next 12 months. And, among all the uncertainty, we learn about the many opportunities that will materialise for investors.

Your host is Ed Whittaker and on the panel we have:

  • Mahdi Mokrane, PATRIZIA’s Head of Global Investment Strategy, Research and Investment Solutions
  • Justin Webb, Head of investment solutions at PATRIZIA Infrastructure.


Mahdi Mokrane

Justin Webb

Listen now:



#11 Outlook for 2023: Looking through the uncertainty

Ed Whittaker: [00:00:00] Permacrisis, polycrisis - whatever you call it, 2022 was a challenging year and the real assets industry wasn't immune to those challenges. But how are things shaping up heading into 2023, and what strategies can investors turn to to stay ahead?

Mahdi Mokrane: The implications for real estate are probably threefold. Leveraged core is gone, income resilience and inflation hedge growth will regain the driving seat. And thirdly, adding value through value add alpha strategies, you know, all these strategies will be highly conducive to our performance in the future.

Ed Whittaker: I'm Ed Whittaker and a warm welcome to the PAT CAST, the podcast from PATRIZIA, the leading partner in global real assets.

With the door closing on a challenging 2022, the new year brings renewed optimism for a global economy adapting to rising inflation, monetary pressures, and geopolitical conflicts. But will the so-called permacrisis persist throughout [00:01:00] 2023?

In the first PAT CAST of the year, we shine a spotlight on the 12 months ahead to understand the key trends and themes that will shape not only the macroeconomic landscape, but the wider investment outlook for global real assets.

On our panel is Mahdi Mokrane, PATRIZIA's Head of Global Investment Strategy and Research, and Justin Webb Head of Investment Solutions at PATRIZIA Infrastructure.

So Mahdi, is 2023 going to be as challenging as last year?

Mahdi Mokrane: You know, there could be no doubt that Europe, and indeed most of the world is facing challenging times.

You know, we've been seeing the largest shock in inflation over the last 50 years linked to the reopening of economies, you know, synchronised global shock and bounce back. Supply chain disruptions, you know, with China closing and reopening as we speak. And then of course, last but not least, Russia / Ukraine War and its impact on food and energy prices.

So what's going on here, and this is a situation in 2023 as we go into this year. Central banks are playing catch up, you know, the Fed is acting decisively, raising rates very aggressively, and other central banks are just following suit. So this has led to the most rapid, the most synchronised and broad-based episodes of monetary tightening in history.

And 2022 is gonna be remembered as an outlier where both bonds and stocks have underperformed to a significant extent, and that has affected our clients' investors, institutional and non-institutional. So where we go from here, I think our central case is one where of stagnation and stagflation, where the weak economic growth and relatively high inflation for at least you know, some time to come the next, you know, 12, 18 months.

And then we'll see a bit of a weakening economic backdrop. And if no sort of further mega shock happens, we'll see a gradual bounce back in economies and easing of interest rates at the back end of this year, early parts of 2024.

Justin Webb: I mean, the macro game in 2022 was all about inflation running away from central banks. I mean, we'd normally sort of see that two to three kind of target range in developed countries, but you, you certainly saw the US inflation peaked at around 9.1% in, in October 2022. In response to that pulse, you saw rising bond yields in many of the developed markets, and it was really the worst global bond returns in more than a century by some measures. We saw the Bloomberg Global Agg Index down minus 13%. And look, it was the worst year for traditional 60/40 portfolios in over a century. That's sort of where we ended 2022 and, and really for 2023 and thinking about it from an infrastructure investing, we see inflation kind of moderately heading back towards targets and sort of close to those targets by 2024.

We're sort of seeing that peak of inflation just sort of happen late last year,and because of that, we've seen the long dated yields. Look, we think they've got a better chance of remaining stable since those dramatic rises over the course of 2022. US bond yields are already down, sort of 50 basis points lower in 2023 than they were sort of in late last year, and we're seeing similar moves in the Euro and and UK.

Ed Whittaker: For the central banks and treasuries, what do you think some of their biggest challenges are?

Justin Webb: There's really sort of two challenges we see sort of facing central banks. The first is balancing that need for lower demand, but with the risk of tightening monetary policy, creating sort of large economic slowdown.

And there's the really, a really important one is managing market expectations. And I think a good example of that is looking at the Bank of Japan, they've had to spend an increasingly high amount of money to defend their yield curve control regime. They target a 10 year band in December 2022 and had to adjust it by 25 basis points, and the market is anticipating more of that to come.

Mahdi Mokrane: All central banks today as we look and try to understand their, what they're doing are facing a deep dilemma. Either they stop raising interest rates and accept persistent inflation and how much sort of that would have an impact on economies. Or follow what the Fed is doing, The Federal Reserve in the United States and risk some kind of financial dislocation.

And the decision really is a function of current account balance, how much foreign exchange reserves they have, they're debt to GDP ratios, you know, private and public and housing bubble risks, etc. And some countries which are more exposed, you know, I'm giving examples here around the world of Australia, New Zealand, UK and a couple of others are gradually adopting what we call a gradualism and are sort of, you know, pausing and, and, and not, you know, hiking interest rates at that fast rate.

Others who have plenty of room for manoeuvre, you know, I'm thinking of Switzerland, Japan, and countries in the Middle East, you know, are, can be more aggressive in, in here. And then the European Union and the rest of Europe, there's a mixed sort of a situation. Sweden, Finland and Italy are more at risk of fast rising interest rates. Germany, Norway, and Denmark are okay and there's a bit of a, despite short term pain in raising those interest rates. And then France, the Netherlands, Sweden, we think they're okay in terms of their government intervention thanks to their mix, their energy mix and mix of energy sources. So I think, you know, given the risks of breaking their economies and creating financial crisis most countries will probably, over the course of this year, adopt this gradualism I was talking about.

Justin Webb: One of the big issues that we're sort of seeing over here in Australia where I am, we're heavily reliant on China. Obviously it, the whole world is, but certainly, you know, there's a real juggling act, um, happening there. The property sector remains an elevated risk. And look, the country is still challenged, plagued by Covid.

It's certainly coming out of their Covid Zero Policy. And they're really now attempting to stimulate that economy as they sort of rebound after those long social restrictions. So we are certainly seeing that a strong economic bounce likely to happen in the short term, particularly where we are in the APAC region.

Ed Whittaker: Great. And looking at real assets now and kind of the macro landscape, what do you think the general implications are for the real asset sector?

Justin Webb: Yeah, well certainly as an, as an infrastructure investor, I mean, infrastructure's, you know, inflation resilience look really is one of the, the main attractions in, in the coming years, and we certainly think that that's true for the infrastructure assets that, that we at PATRIZIA here certainly are are looking at.

Look, as long as the longer inflation hangs out, the more that central banks need to act on it. We see that inflation proofing coming through on, particularly on the infrastructure side, is gonna be a real positive. And there's certainly some issues when it comes to, to inflation. It's not a, it's not a silver bullet when it comes to infrastructure assets, but as a real asset manager, we really do see infrastructure as being really well placed, given these headwinds of inflation that I've just talked about.

Mahdi Mokrane: Listen, I think for real assets, as long as we don't have a deep recession, [00:08:00] and that's our base case, you know, we have a very low probability to attach to any deep recession. I think mainly because of the strength of the job markets and because we have strong fundamentals both in infrastructure. and in real estate, we think the implications for real estate are probably threefold.

I think number one, I would say leveraged core is gone for some time, despite sound fundamentals in most markets. What I mean by leverage core is investors buying, you know, stabilised assets with good income streams in real estate, in commercial property and actually using high quotas of leverage. For example, leverage levels of 65, you know, 60, 65%, you know, LTVs, I think that probably today doesn't work anymore.

And we'll see some erosion in value because of the unwinding of those deals, as the refinancing of those deals will come through in 2023 and beyond. And then the second implication for real estate is that income resilience and inflation hedge growth will regain the driving seat and will drive all components of performance.

In other words, income is gonna be the central piece of performance over the next, you know, part of the cycle. And thirdly, we think there will be some really interesting opportunities. I'm thinking of discounted core meaning core assets that have nothing wrong with them, but have motivated sellers because of what the so-called denominator effect, where the allocation to real assets and real estate in particular has overshot because of the underperformance of the liquid asset classes of stocks and bonds. And then thirdly, adding value through value add alpha strategies, you know, asset management initiatives, repositioning assets, decarbonising assets - all these strategies will be highly conducive to our performance in the future. So three implications.

Leverage core is gone and or will become more difficult. Focus on income and focus on adding opportunities and taking advantage, having dry powder to take advantage of opportunities.

Ed Whittaker: Looking more broadly, do we expect a continued acceleration of the mega trends that we are seeing?

Justin Webb: Oh,absolutely. So, we at PATRIZIA, we really have four megatrends that we are focused on within the infrastructure team.

Certainly decarbonisation and energy transition is one. Digitisation, demographic change and urbanisation and climate change. When it comes to decarbonisation, look, it's the primary driver for capital investment, not only in the short term, but certainly what we see over the next decade. In addition to sort of the more established renewable energy sources such as wind and solar. We're sort of seeing green hydrogen emerging as an opportunity in this space when it comes to kind of energy transition. You know, geopolitical events over the last year with the war in Ukraine have really reprioritised energy security amongst energy transitions.

Mahdi Mokrane: Yeah, you know, I think these four megatrends are going to continue and they'll look through the ups and downs of the current cycles, ups and downs of inflation and interest rates. And I think if you have well positioned portfolios that take advantage of those megatrends, I think we're well positioned to deliver performance.

Ed Whittaker: So with stagflation set to carry us through 2023, there are still clearly challenging times ahead. And while infrastructure can go some way to weathering the storm of high inflation, investors will have to be both patient and agile to capitalise on potentially dramatic shifts when it comes to opportunities to invest in real assets.

Now, we've spoken about the continuing megatrends - but what do we expect to be the key investment themes or sectors for real assets this year.

Justin Webb: So climate change, look, that remains a dominant force in how we invest, in how we manage and how we report on investments into the future. Look, it's a key asset.

It's gonna dominate the landscape indefinitely, particularly because infrastructure assets are, you know, long-term buy and hold assets. Over the short-term horizon, I think the key challenges faced by infrastructure investors in recent years, such as downward pressure on valuations, competition for assets given sort of scarcity of [00:12:00] high quality assets. So geopolitical tensions and the pandemic, they've been an issue and they look, they're gonna continue to be an issue. But really out of all of those issues, like I see as sort of one of the biggest themes, one of the biggest issues to deal with on the infrastructure space in, in 2023 is gonna be the implication of rising rates.

We've seen how rising rates impact on asset valuations, but not only that it impacts on refinancing costs and more broadly curves economic activity. And so rising rates is certainly one of the key areas of focus and, and sort of one of the key kind of headwinds that we see facing infrastructure. But it's not a homogenous asset class and rising rates is going to impact different types of infrastructure assets in different ways, and particularly assets with GDP linkages such as transport, oil and gas. Those assets are likely to be, sort of hit harder than regulated assets just because of the fact that rising rates, the environment that we're in is one that the economic slowdown that we're seeing here means that the revenues of those assets are likely to be sort of hit harder than, than those long-term take or pay contract investments.

Ed Whittaker: So for real estate, how do we see a shift in strategies playing out over the year?

Mahdi Mokrane: I think that really depends on whether you're a core investor or a value add investor. And actually some investors are both, and we have clients in both risk spectrums. But if I just focus my comments on core strategies, as I said earlier, we are at the end of leverage core, and we think that will have, of course, implications for, you know, asset values and the ability to come in and acquire assets at significant discounts. And I'm thinking here of assets that are core in nature and in locations was gonna be a really interesting opportunity. And we've seen a couple of opportunities begin to pop up in the world over the past few months, and I think this will accelerate over the course of 2023 and 2024.

Number two, I think investors and their managers should absolutely focus on future-proofing their core portfolios. This means the portfolio mix should have more alternative property types. To give you just an example. Urban logistics as opposed to big box, maybe student housing in addition to residential. It could be a food anchored retail in addition to any sort of other kind of retail exposure. This should be an acceleration of, you know, uh, sales for those assets that are not, you know, future proof and of course debt management. We know we have more than 200 debt lending relationships at PATRIZIA, and we think that we can leverage those relationships for the benefit of our clients in our, in our debt manage.

And also accept full equity investing and refinancing further down in 2023, 2024. And then thirdly, you know, really keep your decisions as much informed as possible using data. We are an asset class that used to be data poor. We're now data rich. And we can maximise income resilience usings our tools to identify locations that are absolutely futureproof, highly amenitised.

We can use real time asset pricing to optimise the time where we put our bids in the market, our green premiums, you know, whether an asset is benefiting from a green premium or a brown discount. We can use our data. We even have now tools that give us the air quality premium and the optimal logistics and retail catchment areas and we, we believe this is the way forward in positioning portfolios for the core end.

Now, for the value add themes, if you wanna take, you know, you're looking for higher octane returns, we think benefiting from the refinancing challenges. To give you an example, we know there are more than 65 billion euros of real estate mortgages that will mature in the UK over the course of 2023 and 2024 in probably a higher interest rate environment that will trigger sales.

And we think that will be an opportunity to raise capital now to be in a position to take advantage of that. Retail and offices might overreact and over-correct, particularly in a, in a sort of recessionary environment. And then thirdly, we think there's a huge cycle that is opening today for ESG led asset management strategies.

And what I mean by that is locations that are great, but assets that are not necessarily great today and do not cater for the needs of future tenants. And being able to acquire those at a discount, reposition them actively using our skill sets at PATRIZIA and then putting them back on the market. I think that would be hugely satisfying in terms of expected returns. Whether you use low quantums of debt is okay because we, we think in the future when interest rates settle, we'll be able to sell them in a, in a lower interest rate environment, hence with higher prices and higher multiples. So, you know, really investment implications that really defer from the core for the core investor and for the value add investor.

Ed Whittaker: Great. And from an investor perspective, how do we see sentiment among global capital sources develop?

Mahdi Mokrane: We think today as we speak to the global sources of capital, they are, uh, to some extent, I would say on the back foot as they look at Europe because of the geopolitical risks and the implications.

You know, we are a region here in Europe that's been probably disproportionately hit by the energy crisis for good reason. You know, we don't yet produce as much renewable energy and our exposure to nuclear energy is very different from country to country. So I think investors need to understand the lay of the land to be able to reposition for acquisitions.

We've had markets that are, have still kept being active but not as active. They're really slowed down, particularly at the back end, the second half of 2022. We think they will as soon as they get their head around where interest rates will settle, how the recession or not, you know, the slow growth will pan out as we explain our strategies to them going forward. As we raise our, our strategies and our capital for our strategies, we think they'll, they're ready to come back. There's a lot of capital out there looking for a home, and we think Europe will reopen for global sources of capital probably at the second half of [00:18:00] 2023, as those uncertainties I mentioned begin to clarify to be clarified.

Justin Webb: Yeah, we certainly see that investors do have a favourable outlook, uh, for infrastructure and, and that's likely to continue in, in 2023. A recent survey that we monitor showed at the end of 2022 that really, among alternative asset classes, including private equity and venture capital, private debt, hedge funds, real estate and infrastructure, infrastructure, was was the one that CEOs, CIOs, trustees said that they would want the proportion of investments increasing over the next 12 months.

So it's certainly one where, where despite sort of those headwinds infrastructure relative to all other sort of real assets is one where investors are keen to further invest. And when, we're seeing that play out tangibly as well in the fundraising space.

So fundraising and infrastructure in 2022 continued to be strong, outpacing what we'd seen in 2021. North America particularly the fundraising there was, was remarkably high. Um, setting a new record by the middle of the year. And look, that's been really driven by what's been happening, particularly in the US with ambitious fiscal stimulus from Congress, including the Inflation Reduction Act that was passed in August 2022.

So look, those kind of regulatory stimulus are providing sort of strong tailwinds for infrastructure investments

Ed Whittaker: From a kind of strategy perspective, an investment strategy perspective. Which strategies do we expect to continue to be attractive for investors this year?

Justin Webb: Yeah, look, we're at PATRIZIA we're very supportive and really do like mid-market infrastructure.

Uh, look, performance on infrastructure funds show over the last decade that mid-market core and core plus funds have outperformed large cap peers at least by 250 basis points for core funds over a hundred basis, 150 basis points for core plus funds. Really over a 15 year period and look, there's four drivers that we see why we like mid-market, why we think mid-market has outperformed, and why we think it will continue to outperform.

Really we see it has a relative market efficiency. There's a lot more active ownership that we can take as an asset manager. A much significantly higher, broader opportunity set and cheaper entry multiples. So these are the things that we like about mid-market. That's the strategy that we, you know, have seen as being an attractive strategy.

It's one that we do continue to look forward to in where we want to deploy our capital.

Ed Whittaker: Which characteristics of real estate and infrastructure investing do we expect to be the most attractive to investors this year?

Mahdi Mokrane: Again, I think the answer is probably, again, linked to the nature of the investor.

You know, if we're discussing strategies and designing strategies for a core investor, I think the two key characteristics are gonna be the resilience and stability of the income stream and the durability of that income stream, as well as its inflation hedging characteristics. You know, a number of real estate markets around Europe have leases that are inflation indexed explicitly or implicitly, and we think that income component, that strong income component and ability to grow alongside inflation particularly given the fact that we have some strong fundamentals. We, we haven't been building enough real estate in Europe, you know, generally speaking since the GFC. We think that will, you know, contribute to the stability of income. And we're seeing this in our, the performance of our portfolios that we manage.

You know, the 50 billion, circa 50 billion euros of assets that we manage across the region. Now, if you are a value add investor looking for higher octane strategies, I think the overcorrection of markets, particularly in real estate, is probably a feature that you would want to take advantage of.

And then I think lastly, you know, going back to the theme of ESG this is an asset class that is really critical [00:22:00] in reducing our carbon footprint. So the ESG characteristics, the ability to do the right capital expenditure on our assets, our expertise in that domain. Our ability to redevelop or reposition assets is clearly gonna be one of the characteristics that investors will be seeking to take, um, gain exposure to.

Ed Whittaker: Where do you, and where do we see the greatest synergies between real estate and infrastructure this year?

Mahdi Mokrane: I think generally speaking, if you think about real estate and infrastructure, they do obey to the same types of mega trends. You know, when we talked about demographic trends, when we talked about the climate change and the energy transition, when we speak about smartening up cities and using digital tools to enhance the quality of cities, their operational efficiency, as well as operational efficiency of assets, be they, you know, office assets, residential, etc. You know, I think these smart cities and technology is one area where the two asset classes, you know, melt together very well. And I would say that cities that are attractive for our infrastructure, strategies will have more to offer to residents and tenants in the future. So in our book should be more attractive down the line for real estate investing.

Justin Webb: Yeah, absolutely. Look, infrastructure and real estate are certainly complimentary asset classes and, and there are many synergies across the asset classes, but particularly where we're seeing that play out is, is in affordable housing, logistics and renewable energy generation and really the big one that that's a crossover. And we're seeing real estate agents, I suppose, sort of moving in which into a sort of more traditional and infrastructure space is, is really around storage. Around solar and battery storage and data centres, and particularly green data centres. So there's, there's quite a lot of kinda synergies between them.

We're working with projects about, um, given the significant amount of real estate and uh, space on, on roofs, we're looking at solar panels. Uh, we're looking at ways to utilise massive land banks when it comes to, um, our real estate investments in order to create solar or wind farms. So certainly we see a real positive in, in bringing together those two asset classes.

Ed Whittaker: Why is PATRIZIA well set to see through this permacrisis?

Mahdi Mokrane: I think if I just focus on our real estate portfolios, I would say that PATRIZIA is well positioned to see through and even probably take advantage of this so-called permacrisis situation. Probably thanks to the quality of our port, the portfolios that we manage and our sound financial position.

We have never, uh, relied on debt to deliver our investment performance to our clients. You know, we have our income structures are well protected, thanks to our focus on four key themes of our asset allocation and portfolio construction. I think number one, focus on location. You know, we all know that location, location, location is critical.

So we are extra careful in location choice, you know, powered by our preparatory data intelligence tools. We also focus on real estate that caters to the basic needs of tenants to make sure that we have sustainable, resilient income and permanent demand for our assets. We also try to smarten up the buildings and be the landlord of choice in terms of ESG credentials for these assets.

And then I think lastly I'd say CapEx. You know, we spent the right amount of CapEx of capital expenditure to destrand assets and to add features that tenants, you know, continuously demand. So just keeping an eye on what tenants want and will desire in the future is critical to keep, you know,the assets fresh and desirable.

And then last but not least, you know, we have no pressure either to invest or disinvest, you know, we have no, no real pressure to do that. So, you know, we can be ready to capture any good opportunities on behalf of our clients, you know, as we look into 2020.

Justin Webb: We really focus on true infrastructure, those assets that have that physical, tangible presence, long-term contracted cash flows.

Our focus is at the sort of the core, core plus investment opportunities, which we really do think the attractive places to be, particularly in the downward markets that we're currently in. Our focus does remain on that mid-market infrastructure, and we think that that's a really good place to navigate through this permacrisis.

Ed Whittaker: Thanks to our guests, Mahdi and Justin, and thanks to you for listening. I'm Ed Whittaker, and you've been listening to the PAT CAST from PATRIZIA. If you're interested to know more about PATRIZIA's research, Mahdi and the team are more than happy to share their latest findings, so please get in touch.

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