What higher inflation rate mean for Commercial Real Estate?

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The CRE industry is at the edge of inflation. Therefore, the asset classes responsible for generating cash flow now can be used as an added advantage for increasing the rents alongside the other things.

Even though inflation is now skyrocketing to the highest point since the early 1980s, you will complicate the CRE industry’s responsibility for the same. During the first quarter of 2022, the rising price of services and commodities and a decrease in the money value indicated inflation is now in full action.

Even among the investors in the CRE, inflation is now discussed as a significant aspect. Everyone is questioning if inflation will affect the real estate industry. But it has already started showing the results.

No doubt the pandemic has brought in many changes as now people are not restricting investment of their money. But other external factors like the ongoing war situation, the pandemic, etc., have failed to keep up with the pace of the economy.

CRE response to inflation

The CRE is like any other tangible asset which will appreciate due to inflation. It has already been some changes but not in a secure manner. For instance, studies have stated dividend increases in the industry as the REITs have outpaced the inflation in the last 18 years. There have been multiple variables and factors to consider for the same.

For instance, the inflation type matters a lot. Inflation is a response to strong economic growth, which is a good thing about CRE. This is because there is tagline demand in the industry. Inflation is suitable for the CRE industry, but it will depend entirely on the stakeholder and the property type.

The existing developed properties might have benefited by locking a historically low best rate. In such instances, the cost of the property stays constant, but the value will appreciate. As a result, the owners will now have a better hold on the existing assets and enjoy the higher demand and lower supply benefits.

The experts have predicted that Fed will increase the interest rates at least three times this year. The times when there were historically low-interest rates are already gone. In the current situation, things are unstable, but inflation will continue into the year and later. The rising material and labour costs will prove beneficial too.

There will be less competition for the properties developed in the industry. This also results in an increased demand for the existing properties. Further, the short-term leases will turn out to be beneficial.

Inflation and the effect that it will have on CRE will not be the same for buyers, developers, and tenants. Instead, they will experience increased costs of goods, higher interest rates, and fewer available units. At the same time, the developers are likely to pause and adjust to the new project to benefit from it.

In the current situation, time is critical. CRE in the inflation is strategically better considering the long term, like seven or more years. However, as a short-term vehicle, it is misunderstood and won’t even provide proper protection for the more extensive investment portfolio.

The real estate industry is facing the challenges of inflation and is staying strong in all possible ways. By increasing the rental prices and taking other measures on time, they have already managed the market well and ensured people do not suffer too heavy losses.

Understanding the market trends in the current situation and taking measures based on them is extremely important. Still, it is also vital that you consider your long-term goals before making the final investment. After all, there are many things to know about what will work for an investment portfolio and its purpose.

The real estate investment type matters

The CRE industry does not provide the same level of protection against inflation to all sectors or property types in the industry. For instance, industrial real estate and apartment buildings showed that there would be the highest returns in private real estate.

Further, retail is used to protect against inflation because of the short-term leases effectively. However, the pandemic has made retail has moved online, and the market condition has tremendously changed.

The white paper has found that in place and will help the private CRE. At the same time, the public is affected by the effects on the stock returns. The white paper authors have stated that the compounding factor is liquidity.

The private CRE will have less liquidity and be better protected during inflation and economic crises. On the other side, the public REITs will have more liquid and produce a better return when the market increases.

The inflation situation can majorly impact the operational cost of the property value. Some owners can pass the cost to the tenants through variable leases or increase the price. But the others cannot take this method. Moreover, the labour cost will further impact essential properties like hotels.

All in all, when the CRE industry is seen from an investment point of view, then it is a good hedge against inflation. However, the investors need to guarantee that they won’t undervalue the investment or give the opportunity of capturing future revenue.

What can be another scenario?

The real estate industry is showing itself to be quite good despite the inflation situation, but there can be other situations where holding CRE as your investment can bring great harm. For example, some investors might find that shifting their assets away from the CRE will be an excellent strategy to avoid incurring extra costs, either from the higher interest rate or maintenance for refinancing a building.

The signs that indicate such changes are slowing down in the year 2022. The real estate shares received more than 43% as a part of a record high. Now the same claims are falling in a broader market. This means one can be risking their investment in the industry.

In case interest increases because of other factors besides inflation, like if the banking institution chooses to increase the rate to stay strong against the risk of being rebated, then the investments in the real estate probably won’t perform as well as they are doing now. Other forces that weren’t a factor in the previous inflation will come into play, like unemployment, persistent supply chain issues, etc.

Still, one way that CRE would lose its luster is when the ten-year rate on the treasury bonds increases by 3%, which will be more than one percent higher than it is as of the current situation. Until that situation arises, the yields from the properties will be pretty attractive for the investors.

What can happen in the future?

One needs to understand many things about inflation on the CRE and the economy. As an investor, one needs to consider a lot of aspects.

Another is that the period of inflation has been relatively rare. The last such period of inflation situation happened a long ago. Those were when the macroeconomic and economic policy was way too different than now. So, you cannot use those lessons to solve today’s problems.

Due to current inflation, the CRE owners will find it advantageous to sit and wait for the right time. They are at an upper hand in setting the terms and understanding how the property will appreciate in the future.

The value builders, developers, and tenants must consider ways to lock in the cost where they can buy material, negotiate lease terms, and amend contracts whenever they want.

While some might find it an exciting environment for capitalizing on the existing properties and their investment, this is because you will make the property value against the increasing cost in the industry.

The CRE sector and the asset classes are vital. It is critical not to let one factor decide how one must allocate the entire portfolio. One must not let inflation be the sole driver of choosing which asset to invest in, as things can change in the future, and one might face difficulty.

Conclusion

The current inflation situation is quite unpredictable. Understanding the industry first is vital to making an investment or saving the current one. This would require some expert knowledge and assistance.

You can get in touch with Private Capital Investors to get professional support. They have got professionals for help. They know how to handle the job with care. No matter the assistance you need, the professionals will be there to make things better for you. With professional help, you will quickly understand the market conditions and keep the investment safe with a worthy long-term goal.

Want to learn more? Get in touch with us today.

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