This article was produced in partnership with Colonial First State.
The growth in AI technology will not only underpin equity investment but have far-reaching implications into other asset classes.
One example is with real estate investment trusts (REITs). Despite trading at a double-digit discount to private market real estate in 2024, global listed real estate is set for a rebound, driven by solid balance sheet foundations and an acceleration in earnings, off the back of organic and external growth, according to CBRE Investment Management which is one of the equity managers available on the CFS Edge platform.
CBRE global portfolio manager Justin Pica tells Professional Planner the sector’s growth outlook was underpinned by a favourable interest rate environment and a beneficiary of the generative AI boom.
“We don’t expect the valuation discounts [seen in 2024] to persist,” Pica says.
“Historically, global listed real estate has delivered returns in the mid to high teens following these sorts of dislocations.”
Pica says there’s already been recent improvement in global listed real estate valuations.
“Some REITs [are] trading closer to, or at a premium to, our view of net asset value,” Pica says.
“As valuations normalise, we expect the performance of global real estate to rebound.”
When it comes to interest rates, the pause in central bank rate hikes was “powerful” for the REIT sector, and rates did not need to plummet for the asset class to outperform, Pica says. Other positive signs included the sector’s strong access to capital, relative to private markets, and the unique requirements of generative AI.
“Real estate has historically done well in range bound periods where long-term yields have been similar to the levels they are today,” Pica says, citing the US market from 2001 to 2007, when US 10-year yields hovered around 4 to 5 per cent and global listed real estate delivered strong double digit returns throughout that period.
“Real assets in the form of data centres and infrastructure have bottlenecked generative AI development because of demand combined with constrained supply.”
This scarcity has caused prices to soar in many cases, creating “very attractive” opportunities for REITs that service this area, he says.
Conquering new territories
T Rowe Price, which is also available on the Edge platform, believes demand for land and particularly data centres and associated infrastructure was also creating “second derivative opportunities, beyond Nvidia”.
“There are bottlenecks in terms of how these data centres are powered and they’re also really hot, so they need access to water for cooling,” the investment manager’s international equities portfolio specialist Sam Ruiz says, adding that the generative AI mega theme was supported by US$200 billion ($321 billion) of capital expenditure from big tech, which was on track to hit US$500 billion by 2028.
While the impact of that expenditure on Australian data centres and demand for land is unclear, there was a clear shift from standard public cloud to AI cloud, which formed part of a “huge investment cycle,” Ruiz says.
“This [theme] is real and it’s going to be here for a long time,” he says, although it did not mean T. Rowe Price was “bullish” on the sector.
From a public equity perspective, Ruiz described investment as “close to the beginning of the end of the initial cycle”.
While companies like Microsoft, Google and Meta have vowed to continue investing heavily in generative AI, T Rowe Price is “a bit cautious” that at some point this investment and expenditure may start to hurt the free cashflow yields and free cashflow multiples of these companies.
“If they can’t prove the return on investment then investors will start to hold them accountable for where they are spending their money,” he says.
Looking at the bigger picture
According to Pica, global listed real estate investors are ideally positioned to capture opportunities stemming from the generative AI boom, due to healthy balance sheets with conservative leverage around 30 per cent and modest pending commercial debt maturities through to 2026.
“The access to capital advantage that public REITs have right now affords them an opportunity to go on the offensive and boost their earnings through acquisition, and ignite a virtuous cycle,” he says, pointing to HMC Capital’s establishment of a new ASX-listed digital infrastructure REIT (DigiCo REIT).
“We now have our first data centre REIT in this country and [this deal] reflects not only the investment in this space but the ability for public markets to be able to put these types of deals together.”
Notwithstanding the opportunity, Ruiz pointed out that there are also plenty of opportunities elsewhere. Currently, the biggest underweight position for T. Rowe Price is IT.
“We’re underweight semi-conductors, semi-cap (semiconductor capital equipment) and IT hardware,” he says.
“We’re actually repositioning our portfolio to more ‘real economy’ stocks, particularly in the US.”
Ruiz says the asset manager believes the Republication sweep in the US federal election last month extends the thematic of US exceptionalism and they are bullish for corporate profits and companies exposed to the industrial economy and financial sector.
“The US economy has been good at the headline, but the industrial/manufacturing sector has been doing it tough for two years,” Ruiz says, adding the Purchasing Managers’ Index – an indicator of the prevailing direction of economic trends in the manufacturing and service sectors – has been significantly low the past two years.
“We expect this to recover in 2025 and we see opportunities in industrials as a result.”
