What Inflation means for Commercial Real Estate Investing

What Inflation means for Commercial Real Estate Investments

As you’re aware, inflation has increased significantly. The U.S. economy hasn’t seen an increase at this level since the late 1980s. So it’s no surprise that this is a hot topic in the news and presents a big question to investors about how it will affect their portfolios including those who have commercial real estate investments.

This round of inflation is being driven by “demand” such as:

  • stimulus payments
  • re-opening of businesses
  • excess in savings and spending

and supply-side issues such as:

  • labor shortages
  • supply chain disruptions

If these trends continue then inflation will remain in an increased state during the upcoming quarters. But as the supply-side disruptions get worked out we can expect to see that part of the equation decrease, ultimately relieving some of the inflationary pressure by allowing demand to be met.

As it relates to commercial real estate it’s expected that as long as the current inflation trend follows the most probable based on historic data it will result in a slight increase in returns and lower cap rates. To be more specific it’s common to see for every 1% of inflationary increase you can expect to see 1.1% in returns.

What Protects Successful Commercial Real Estate Investments During Periods of Inflation?

While we’ve seen that inflation can have a positive impact on commercial real estate investments in some cases, it’s still very important to focus on the factors that you can control which will assist in protecting your assets even further.

Here we’re sharing a few of the factors that will assist in protecting and making your commercial real estate investments successful.

Hold Period (relation to the inflation cycle)

Due to the fact that the Fed will increase rates when inflation is high it of course becomes more expensive to borrow money. This means that any capital borrowed is likely costing you more, which can reduce the amount of buying interest in the market. By matching hold periods to ensure exits (and purchases) are timed to maximize returns where buyers are active you can avoid a decrease in returns.

Lease Duration

Lease structure and duration can be optimized to hedge against inflation as well. For example, having some property with shorter lease periods allows for rental rates to be adjusted during times of increased inflation to ensure you maintain positive cash flow and higher returns. But as inflation begins to stabilize a move to enact longer-term leases will be advantageous in your portfolio.

Mitigate Risk Against Inflation Through Investment With Commercial Real Estate

So the big question is “How Can I Best Protect My Commercial Real Estate Investments During Periods of High Inflation?”. 

Ensuring that commercial real estate leases are structured to include annual rent increases will provide a cushion to accommodate the increase in expenses due to inflation. This way real estate assets can serve as a hedge against inflation.

CRE builds these increases into every lease agreement.

The impact of these increases generates a rise in income, which leads to increased values. As long as the rate of an increase outpaces inflation, the relative return is positive.

Property scarcity can cause price increases to outpace inflation.

CRE focuses on assets that have this scarcity in mind by, for example, focusing on dense real estate markets where there is a limited supply of space. High demand and the limited supply is a winnings formula when prices are rising. As long as price increases outpace the rate of inflation, returns will be positive on a relative basis.

At CRE Income Fund we utilize these strategies to ensure you have access to creating a broadly diversified investment portfolio.

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