CRE Doesn’t Have to Worry About Inflation Yet

While there are widespread concerns about inflation, so far, the rise in interest rates has been because of better growth prospects, according to Cushman & Wakefield. Those positive dynamics also mean good things for real estate fundamentals.

Right now, the market is indicating that “unanchored inflation” is unlikely, according to Cushman & Wakefield. It says low interest combined with transparency from The Federal Open Market Committee justifies the valuation of interest-rate sensitive assets.

Despite the pandemic, there has been little movement in headline cap rates since December 2019. Across product types, cap rate spreads are elevated above the long-term average by about 100 basis points. “This indicates an ability to absorb upward movement in the cost of capital without imminent pricing downsides,” according to C&W.

Even if inflation isn’t a concern yet,  supply chain and construction costs are rising. That means higher build-out costs for occupiers and higher budgets for inputs for developers, according to C&W. Still, C&W says the cost of financing will be supported by accommodative monetary policy.

For investors, better economic fundamentals mean improving inflation data and recent increases in the 10-year Treasury rate, according to C&W. Those trends should boost NOI performance. Still, real estate is local. Performance will vary based on market dynamics and product type. But for now, Fed policy remains supportive of liquidity and pricing, according to C&W.

In a separate analysis, David Rea, JLL’s chief economist for EMEA, expects inflation across G7 countries will likely climb toward 3% and remain high for much of 2022 before sharply falling again.

The net result, Rea says, is that inflation should average around or slightly below 2% over the duration of the pandemic and immediately thereafter.

Inflation across G7 countries has dropped precipitously since January 2020, with a decline from 1.7% to 0.6% at the start of this year. But broader, emerging economic recoveries signal rising inflation—and clues as to how much inflation will increase will “ultimately drive decisions over what assets are best to buy, sell or hold,” JLL notes in a recent analysis.

“A rebound to 2% would be a big shift compared to today—but would be in line with the rate that most central banks are targeting,” Rea said. “For inflation to escalate, it would have to jump to at least 3%, and stay there for several years. If inflation did surge, bonds and fixed income assets and securities would bear the brunt of the impact, with their income streams eroded.”