Are Commercial Investments a Hedge Against Real Estate Inflation?

In recent news, the Congressional Budget Office (CBO) illustrated how  high inflation could continue into 2023. With the federal government having to pay higher prices on its debt, the cost of real estate capital is expected to increase steadily. Thus, investors in the field are seeking safer prospects that will net them a steadier income and outpace inflation. Below we will break down how real estate inflation operates and how commercial accounts could be the answer given our economic circumstances. 

What is Real Estate Inflation?

Generally, inflation is the increase in the cost of goods and services within our economy, measured on a year-to-year basis, which results in a decrease in buying power with our currency. Real estate inflation is affected by numerous economic factors but can actually have various pros and cons for an investor. These inflammatory economic periods create a trickle-down effect where mortgages are harder to obtain so renting becomes a more attractive option, in turn raising rental prices. 

Demand-Pull Inflation (DPI) is a positive principle for investors. When demand for a particular market service increases, the supply decreases leading consumers to pay more for said services. While renters will be willing to pay more they will still seek competitive pricing so they can actually rent. If the dividends of your residential investment cannot keep up with real estate inflation then you can lose money by lowering rental costs. 

Though we have central banks—such as the Federal Reserve—to monitor inflation and adjust monetary policy, there is only a 2% differential that such institutions can adjust for. With the Consumer Price Index expected to rise 6.1% this year, investors are rightly hesitant to place their money in high-risk high-reward real estate accounts because capital for costly projects today depreciates in purchasing power tomorrow. 

The Consumer Price Index is a measurement detailing the increased cost for a limited basket of goods and services. As demand for rentals rises, the cost of goods to build and maintain such projects rises, as described by the principle of Cost-Pull Inflation (CPI). All these factors combined have shown investors moving away from residential rental accounts, seeking a steadier revenue stream. 

 Takeaways: 

  • DPI is an increase in demand for a product/service (i.e. supply and demand
  • CPI is a decrease in the supply of goods 
  • Consumer Price Index measures general inflation for the market at large

 How Commercial Real Estate Protects Against Inflation

Commercial real estate (CRE) includes properties that have five or more rental units but offer a wide range of office, retail, industrial, leisure, and even healthcare operations. Typically, these accounts have businesses operating out of them. Most residential investments cannot keep up with the current real estate inflation, while commercial real estate offers security against the high individual risk of residential accounts. CRE affords more partnerships that will help navigate your investment against the various factors affecting inflation. 

 Rent Income Increases

There are numerous factors that make commercial real estate a great real estate inflation hedge, primarily in CRE’s ability to outpace inflation. Residential investments are more at the mercy of market fluctuations while CRE includes clauses that regularly increase rent between 2-5%. Additionally, commercial properties include the principle of Net Operating Income (NOI) which measures property revenue minus the necessary operating expenses. 

A commercial property with a steady or rising customer base increases revenue, outpacing operating costs which boosts value and leads to larger rental costs. However, this can be a delicate process, and trying to find the right market to invest in can be difficult to go alone. Consider consulting a professional broker who can provide you with the expertise to buy CREs directly which provides more personal control and higher dividends on investments than REITs or equity firms. 

 High Demand, Limited Supply

The economic forecast predicts CRE’s as a growing commodity, particularly in the industrial sector, leading large companies to sign contracts even before spaces are built to avoid losing access. Scarcity of accounts leads to rental costs rising and as demands become denser, prices appreciate outpacing real estate inflation. 

CREs will typically net returns ranging between 6-12% and with the rate of demands limiting the supply, these ranges could even increase, making it an opportunistic time to invest in commercial properties. 

 Takeaways: 

  • CREs outpace inflation by generating revenue from businesses by calculating Net Operating Income (NOI).
  • Scarcity drives up demand, increasing returns on investments (between 6-12%) 

 Final Thoughts

If you’re seeking steadier returns, commercial real estate investments could offer the real estate inflation hedge you’re seeking. Though the market may look volatile, the high demand for CREs is driving plenty of exciting new opportunities that you should navigate with a professional partner.

 

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