The past two years have been filled with unpredictable events, to say the least. As a result, we’ve seen inflation skyrocket. As a commercial real estate investor, it’s crucial to understand what the rise in inflation may mean for your investments.
Luckily, commercial real estate is considered a stable asset class, and therefore, is not subject to as much inflation as, say, durable goods. Here, we’re going to give a brief overview of CRE and inflation and how inflation impacts your CRE investments.
Let’s dive in.
What is Inflation?
Inflation is a hot topic right now, but what is it?
Inflation refers to the continuous increase in the prices of goods and services in an economy. This continuous increase is a result of the rate at which the value of a currency is falling.
Inflation, in short, follows the idea that a dollar in ten years will not be worth as much as it is today. For example, you’ve probably heard your parents or grandparents talk about how inexpensive a cheeseburger or candy bar was “back in the day…” That’s inflation in its simplest terms.
The level of inflation in an economy, according to Investopedia, is subject to change based on current events. Some of the most popular representations of inflation in history occurred in 1991 and during the financial crisis of 2007–2008.
As of late, people (and investors especially) have had their eyes and ears out for an inflation crisis as a result of the COVID-19 global pandemic—and rightfully so.
In fact, inflation, as described by one of our OC broker teams on their blog, is likely “the biggest economic threat we all face now… as it impacts every aspect of the American economy. It is now running at the highest level in 40 years with little sign of abating anytime soon. In November 2021, the Consumer Price Index rose at an annualized rate of 6.8%.”
Given inflation’s unpredictable behavior, people are searching for a stable asset among the chaos. How exactly will inflation affect your CRE asset?
What Inflation Means for Your CRE Asset
When it comes to leasing agreements for commercial property, it is not uncommon for rent to increase periodically throughout the duration of the lease. Forbes Advisor provides an example of a clause that calls for an annual 2 to 3% increase in rent. These increases, of course, will depend on the specific asset as well as market supply and demand. However, “as long as these regular increases outpace the inflation rate, the relative return will stay positive.”
Pay Attention to the Value of Your Property
Owning and renting out real estate works nicely when paired with inflation. The reason being that property values increase alongside inflation, which, therefore, allows landlords to charge higher rents to keep in step with inflation.
American author Mark Twain once said, “Buy land, they’re not making it anymore.”
While extremely obvious, of course, it’s true. Although more and more commercial properties are constructed each day, we have and will continue to experience shortages in our respective SoCal markets. As more cities see greater development, the amount of land available to build will decrease, therefore increasing the value of your existing property.
Let’s remember, as an example, all throughout 2020, industrial properties sold at record-breaking numbers. Businesses were head-to-head against one another in an effort to secure quality space.
This is a positive for investors, as explained by Forbes Advisor. “In dense real estate markets and commercial centers, high demand and limited supply contribute to the appreciation of prices for real estate… So, if the price increases are more than the inflation rate, the relative return stays mostly positive.”
How Do I Start Investing?
There are many asset classes that continue to perform at relatively stable levels during inflation spikes. Examples aside from CRE include gold, treasury inflation-protected securities (TIPS), and commodities like metals and oil.
We’re biased, of course, but we think investing in commercial real estate is the best option (and most fun!)
Interested in investing in a commercial property? Check out our blog to hear Greg Marx, Vice President and Partner at Voit Real Estate Services, detail nine reasons why it’s a good time to buy a building right now. Then, get in touch with our team today.