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Real Estate Is The Hedge Against Inflation

As supply disruption starts to dissipate and the denominator effect leads to an inevitable fall in the rate of annual CPI increases. It is expected that popular concern to moderate and pressure on policy rates to ease next year. Interest rates will be higher than in recent years but will remain low by historic standards.

Theoretically, it is reasonable to claim that real estate is a good hedge against inflation appears. All other things being equal, during periods of inflation one would expect the rent on commercial property to rise along with the price of other inputs such as raw materials, goods, or labor. Lease renewals or rent reviews allow rents to be “marked to market”. Leases may also include explicit annual indexation of rents to some specified measure of inflation, or pre-set step-ups in rents over the term of the lease. They may also allow expenses such as maintenance costs to be passed through to tenants, protecting the net income of the owner.

The strength of the link between inflation and rental income growth will be heavily influenced by other factors – particularly the balance of supply and demand in the market which determines whether landlords can, in practice, increase rents. The type of inflation also matters. If costs are being driven up by “demand pull” from strong economic growth, it is expected that real estate demand – and rents – to rise. On the other hand, landlords would find it harder to raise rents when “cost-push” inflation is driven by rising prices but without an associated increase in demand. It is also expected that the relationship to vary between countries and property types depending on the way leases are typically structured. But overall, apart from short-term distortions due to the property cycle, it is expected that income – and thus property values – to keep pace with inflation over time.

Keith Knutsson of Integrale Advisors commented that “Real estate is a good hedge against inflation and the balance of supply and demand will determine rental income growth.”

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