How to Know if a Building Will Deliver as an Inflation Hedge

Commercial real estate has long been regarded of an inflation hedge of sorts — but investors would be wise to do their diligence on demand dynamics and vacancy rates within individual markets, according to a new analysis from Nuveen.

“Real estate can keep pace with inflation assuming it is the right building, in the right location with sufficient demand to support higher rents,” Nuveen analysts write. The firm recommends focusing on asset types like medical office properties in high growth cities and suburbs, or single-family rental or multifamily assets in the Sun Belt.

And for those wondering if there’s any upside left to capture, Nuveen says the answer is a yes, at least for strategic market segments.

“Sector dispersion has been a long-term trend, and active managers are building portfolios accordingly,” the report notes. “Short-term returns will likely be driven by non-cyclical properties less affected by downturns: medical offices, data centers or self-storage. Active portfolio management will be key to driving performance in a slow growth economy.”

Nuveen analysts also reviewed historical data going back to the 1970s to conclude that real estate “tends to perform relatively well in rising rate environments in absolute terms, but even more so relative to interest-rate sensitive assets.” Since 1977, U.S. core real estate has averaged annualized returns of 12.6% during rate hike cycles and 10.2% in the year following, the firm says.

“Even in this rising rate environment, we believe private real estate offers opportunity,” the analysis notes. “Public REITs behave very differently compared to private real estate because values may be influenced more by equity market sentiment. Public REITs have significantly higher volatility and offer shallower markets, as not all property types are represented in REITs in all markets. In Europe and Asia-Pacific, REIT markets are a small fraction of the size of private markets.”

And while growth rates will likely slow across CRE sectors, fundamentals are strong, with record-low vacancies across the residential and industrial sectors.

“A recession would not affect all global markets equally, which should help global well-diversified investors achieve a smoother ride,” the report notes. “We believe real estate markets should benefit from long-term structural trends. Urbanization continues, as well as the drive for more sustainable buildings. Technology should continue driving job growth, and e-commerce supports growing market share. In addition, some trends favoring local real estate may gain traction, such as re-shoring of production to developed markets in the U.S. and Europe.”