The economic downturn induced by the ongoing and seemingly endless pandemic has made ‘inflation’ a buzzword. Everyone is talking about it, and you already know what it is. From a consumer perspective, it means that you need more money to purchase goods.
And from an investor perspective, it means that you need to earn returns equal to or higher than the inflation rate to ensure that your capital’s value doesn’t dwindle.
The U.S. has gone through 19 recessions in the past 100 years. The government has historically chosen an inflationary approach to deal with these down markets—and it has chosen the same strategy in response to the pandemic-induced recession we are currently facing.
The Fed has pumped $342 billion into circulation since March last year and is continuing to print money with the idea of supporting the economy by stimulating spending.
The current inflation rate is hovering in the 5% range in 2021—a stark contrast from savings account interest rates of just 0.6%. So there is no doubt that we are indeed in an inflationary environment and that, as an investor, you need to look for instruments that will help you preserve and even grow your capital in this context.
Commercial property – A good hedge against inflation
The good news for commercial property investors is that real estate, in general, has long been considered a stable and even attractive investment during times of inflation. Many experts agree that putting money in commercial properties and holding those assets long-term can help protect a portfolio when soaring inflation rates.
But even though most types of commercial properties perform pretty well in inflationary markets, certain aspects of such investments affect how well they fare out. The three most important aspects are lease duration, premiums on existing investment assets, and holding period. Let’s talk about each one.
How your leases are structured may affect returns during periods of high inflation. For example, properties with short-term leases benefit most from inflationary environments because rental rate adjustments can be made whenever a lease expires. This is why you’ll see short-term yields increase when higher inflation rates are expected. Conversely, long-term leases and flat rental rates won’t benefit as much in an inflation scenario.
Premium on existing assets
Inflationary pressures make material and labor much more expensive while increasing interest rates and making it costly for investors to borrow money. When all these factors combine, developers have less incentive to build new commercial properties from the ground up. This has the effect of limiting supply, which then sets a premium on existing high-quality commercial properties.
Holding period as it relates to the inflation cycle
The Fed typically raises interest rates when inflation rates are higher—and as mentioned, it becomes much more costly to borrow money when interest rates go up.
Many commercial property investors rely on debt to purchase real estate assets, and the expensive best of debt lowers demand and ultimately causes commercial real estate values to decrease.
This is why it’s not a good time to sell during periods of high inflation. Instead, seasoned investors can afford to wait to choose to do so until inflation rates stabilize and interest rates go lower.
Most investments suffer during inflationary periods, so many investors are understandably on edge. But it’s not all hopeless. Strategic and well-chosen commercial properties can provide a hedge and help you protect the value of your money.
Commercial real estate investors can expect some opportunities and waves of momentum in a high inflation market.
Despite the uncertainties of an ongoing pandemic, this is a particular time for commercial property investors to rebalance their portfolios and take advantage of multiple yield generating opportunities—the key to success is to understand how to position your investments to ensure positive returns.
When appropriately managed, investment properties held for a long time may offer a secure and sustainable way to grow the initial seed money into something more substantial for the future.
Alternatively, if you would like to put money in commercial real estate but don’t want to own the hard asset yourself, you can look into real estate investment trusts or REITs.
Similar to mutual funds, REITs essentially pull together funds from different investors to purchase and manage commercial real estate assets. They are much more liquid than actual properties, making them attractive to investors who are new to the world of commercial real estate and those who want quick access to their funds should they suddenly need it.
In addition, REITs are proving to be quite resilient against inflation. You may want to consider investing in them if you want a more liquid and passive way to grow your portfolio in an inflationary environment.