Direct ownership in an alternative asset class
Property Income: is derived by lease payments, and generally speaking, inflation will typically put upward pressure on rent rates. If investors/owners can increase the lease rates, it is a natural hedge against inflation. But it doesn’t impact every sub-sector the same. Properties in industrial and office sectors typically are 4+ years in length, with anchor tenants often having a ten-year or longer contract. In those cases, the cash generated is basically fixed, and real returns would be reduced by inflation. Contrast that to multi-family or hospitality where lease terms are measured in one night or up to 1 year for an apartment, and adjustable rents can help hedge against inflation.
Property Value: is most often calculated based on net operating income and a cap rate. The higher the cap rate, the less valuable the property. The lower the cap rate, the more valuable. Oversimplifying to illustrate, historically, cap rates move up as interest rates rise, and interest rates generally move up to counteract inflation. Yet, it’s again not that simple. There is a counterbalancing force. As prices for materials and labor move up with inflation, new construction is more expensive, leading to higher valuations for both new construction (likely in lower supply) as well as existing properties. We see that happening today with big rises in single-family home prices.
Interest rates for borrowing: inflation devalues currency which causes lenders to charge higher interest rates to make a profit. Like increases in raw materials, that causes developers to be more selective on new construction, which in turn limits supply and consequently increases values in existing properties.
Market Demand: if income, value, and interest rates aren’t complicated enough, the demand for real estate is another variable that impacts real estate performance. Historically, investors demand for hard assets increases during inflationary periods, including real estate, precious metals, and oil which then tends to move values up.
Does real estate provide a hedge against inflation?
Real estate can be an effective hedge against inflation generally. The appreciation in value (not the income production) can work to offset inflation.
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