Inflation Means Different Things to Developers, Investors, Tenants
Hard assets such as commercial real estate tend to retain their values during periods of high inflation.
Not that we needed it, but last week we received another indicator that inflation was on the rise when the Bureau of Economic Analysis reported that the personal consumption expenditures price index rose 6.6% over the 12 months ending in March and up from a 6.3% annual inflation rate in February.
Inflation, in short, shows little sign of peaking as some economists had thought would happen by this time.
The question for the CRE industry is what impact this will have on assets and investment behavior. The truism that real estate is a good hedge for inflation is only partly true as some assets are better able to withstand price increases than others. Smart investors looking for a hedge know this and will place their capital accordingly.
On the other hand, equity CRE investors should be able to benefit from pricing prices. Nareit research has shown that dividend increases for REITs outpaced inflation in 18 of the last 20 years.
Another problem is that developers are facing persistent pricing challenges for materials and labor.
Margette Hepfner, COO, residential management, Lincoln Property Company, speaking during a recent webinar hosted by Grace Hill and Apartments.com, said that one home developer told her that pre-pandemic, their average entry-level home was $300,000; and today, it’s $600,000.
“Nothing is different about the home,” she said. “Not a higher profit margin, etc. It’s just the rising cost of everything such as materials supplies and labor. So, these homes that renters are looking to transition into just aren’t there.”
That pricing pressure carries over to most developments. Commercial real estate tends to appreciate in value proportional to inflation, writes PBMares, an accounting and consulting firm.
There are several variables and compounding effects to consider, Ryan B. Paul, CPA, wrote in an April 7 PBMares blog.
“Inflation as a response to strong economic growth is a good thing when it comes to CRE; inflation because of persistent unemployment and stagnant demand is not,” Paul wrote. “In the current environment, inflation as it stands will be good for CRE; but then again, it depends on the property type and stakeholder.”
Inflation—and its effect on CRE—differs for developers, buyers, and tenants. Paul said that developers, when experiencing the rising cost of goods and higher interest rates, “are likely to pause or adjust new projects.”
He said one exception is for tenants who were able to lock in a long-term lease with guaranteed low rent increases; “they will see a similar benefit as owners of existing developed properties,” Paul wrote.