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CRE as an Inflation Hedge . . . Or Not
An old adage is that investing in real estate, especially commercial real estate, can be an ideal hedge against inflation. Investors and owners can increase rents to counter other rising costs. Furthermore, those same rising costs, combined with labor and supply-chain shortages, mean fewer new developments and less competition. But the Wall Street Journal recently threw some wrenches into the CRE-as-inflation-hedge argument. According to Vikram Malhotra, managing director, real estate equity with Mizuho Americas, some investors are not so confident of real estate as a hedge against inflation, as evidenced by the fact that real estate company shares are underperforming the broader stock market so far in 2022. This is a direct shift from 2021, during which real estate stocks gained more than 43%, outperforming the S&P 500 by about 15 percentage points.
So what’s going on?
One concern is that persistent price increases could drive up long-term interest rates. When it costs more to borrow, owners are less likely to refinance, and asset values can decrease. Speaking of interest rates, the Federal Reserve is planning to wind down its bond-buying stimulus program in an attempt to curb that inflation. This, in and of itself, wouldn’t pose a hardship to CRE investments – unless banks push up their own rates out of fear of being repaid due to overall economic worries. If this is the case, “that is very uncomfortable for real estate values,” according to Cedrik Lachance, Green Street’s Head of Research.
Malhotra indicated that in previous periods of high inflation, REITs outperformed the broader market. But the current situation is different from previous times, due to supply chain shortages and the Great Resignation, in which more and more people are quitting their jobs. In such a situation, inflation might not so readily contained, meaning an increase in long-term rates, Landlords might not be able to continue raising rents because tenants might not be able to pay more.
Analysts note that as long as 10-year Treasury yields remain well below 3%, real estate can remain a viable investment during inflationary times. But “some of the pros who have been around for awhile are standing back from the market,” Darrell Wheeler, Moody’s Analytics’ Senior Analyst of Commercial Mortgage Backed Securities told WSJ.
- ◦Financing
