Is CRE Truly an Inflation Hedge?

The general narrative about commercial real estate and inflation is that the former tends to be a hedge against the latter. Real estate often maintains or increases in value during periods of inflation. Furthermore, leases with built-in rent increases are likely to generate a decent rate of return.

However, commercial real estate involves more than just one asset type. A recent analysis by Marcus & Millichap tested the relationship between rent growth and inflation, using the Pearson Correlation Coefficient to measure the behavior of these two variables over 25 years.

One factor the researchers uncovered was that inflation pass-through varies by property type. “Lease length, contract terms and demand shifts help explain why office, retail and industrial rents show weaker-to-moderate links with inflation,” the report said.

For example, longer office lease terms and a limited use of rent escalators demonstrate this sector’s weakest relationship with inflation, with a 15.9% correlation between rent growth and changes in the Consumer Price Index.

At the same time, retail rent growth showed a 39.4% correlation with inflation, as leases tend to include built-in rent escalators. Industrial rent growth showed a 49.2% correlation, “supported by rent escalators that may be fixed to CPI,” the Marcus & Millichap analysts said.

Meanwhile, self-storage, multifamily and hospitality assets demonstrate the strongest resistance to inflation, with the correlations at 51.3%, 63.1% and 65%, respectively.

The analysts said that the self-storage result was based on eight years of data, with pandemic-related demand shifts, increased construction and discounted street rates influencing the correlation.

Apartment leases are typically annual, meaning a higher level of rental reset, while hotels showed the strongest rent-growth-to-inflation relationship. The analysts explained that the data reflected daily rate adjustments, “while about 42% of the variance in rent growth is statistically linked to inflation.”

While rent growth-CPI increase correlation differed depending on asset type, “stronger correlations across most major property types suggest CRE may offer more inflation resistance than equities, especially in a prolonged inflation environment,” the brief said.