Investing in Real Estate against inflation
With long-term property appreciation, real estate investors can generally mitigate the effects of inflation. Let's see how.
The markets fear it, investors dread it: inflation has been at an all-time high in forty years and shows no sign of letting up. So, what to do? You should play defense and focus on real-yielding assets, which generate cash flows that are positively linked to inflation, as in the case of real estate. Within this industry, there are some particularly resilient segments where inflationary pressures represent an opportunity rather than a threat.
Why is real estate a good investment in times of inflation?
Real estate investments offer an excellent hedge against inflation as they produce returns that take into account changes in the economic environment. In fact, as the purchasing power decreases, the average property values tend to increase and with them also new and existing leases, which represent an important component of real estate investment. That's because it's common to include clauses in rental agreements that adjust rents for inflation. As a result, the asset increases in value over time, and the owner has an investment that’s well protected against inflation risk.
It should also be noted that the closure of construction sites during the pandemic first and the high increase in the price of raw materials later led to a slowdown in new real estate developments and construction projects. As a result, supply stays low while the value of existing properties rises, benefiting the owners who invested in them.
Real estate is a long-term investment
Investing in real estate as a hedge against inflation is most beneficial when done over the long term and in good time. The long time horizon allows the investment to mature, so as to be able to deal with stress phases on the market, like the current one. Planning ahead and taking advantage of certain real estate segments and products is key, otherwise there's a risk you won't be able to cover the increases in operating costs through leases.
Not to mention that making real estate investments in an already inflated economy will certainly be more expensive due to inflation increasing the prices of goods and services.
Which assets to invest in?
When inflation hits, choosing which asset class to invest in is crucial, and a lot depends on how quickly and often rents can be adjusted. In addition to core office properties that offer very attractive returns thanks to the indexation of rents, it’s essential to focus on those businesses that don’t experience slowdowns or can handle rent increases better than others. This is the case of data centers, a segment constantly expanding in the wake of increasingly digital economies, but also logistics, for which rent expenses represent a minimal part of management costs.
On the other hand, a sector like hospitality would require more in-depth analyses. Even though room prices can easily be adjusted to cover a rise in rents, hotel stays are discretionary expenses and when times get tough they're often cut back. The same goes for the residential sector: while it's true that rental agreements can be adjusted based on the economy, more and more countries are capping increases, which reduces the potential of the real estate investment in times of inflation.
Finally, properties that meet ESG criteria (an acronym for Environmental, Social and Governance) are what investors are looking for now that they're paying closer attention to environmental and social sustainability. Also, since they are cheaper to manage, these assets are a smart choice against rising operating costs during inflation.