Inflation is Here. What Does This Mean for Performance and Pricing of Commercial Real Estate?

November 3, 2021

It’s Economics 101.  Input costs have increased sharply due to spikes in commodity prices, supply chain interruptions and, most importantly, a brisk structural metamorphosis in labor markets that were scrambled by the pandemic.  At the same time, between January 2020 and August 2021, the Fed’s aggressive Quantitative Easing policy increased the money supply (m2) by 34.4%.

These factors underlie the dramatic across-the-board inflation we are feeling today for virtually all types of goods and services.  Right now, it is unclear if high inflation is a temporary phenomenon or if it is the beginning of a major structural shift.

For those of us in the CRE industry, the economic environment in the U.S. over the last three decades has allowed us to make the subject of inflation an afterthought.  Our financial models have typically assumed a flat general inflation rate of 3.0%.  This “easy button” approach may be coming to an end. Suddenly we must confront the potential for a more complicated and volatile inflation environment with significant variances by region and property type.

At this point, there are more questions than answers.  In many cases, we can only guess how the interaction of these various inflationary drivers will impact performance and property values.

Historically, investors have considered CRE an inflation hedge, albeit an imperfect hedge due to lags in price adjustments and longer transaction times.  As we close out 2021, here are a few questions that come to mind:

• Do properties with more frequent repricing, like hotels and apartments, benefit from the new inflation environment?
• Will landlords insist on leases with higher or more frequent inflation adjustments?
• Is the U.S. Consumer Price Index a fair measure of inflation for CRE?
• Will inflation drive cap rates higher due to significant increases in the cost of debt and equity capital?
• Will investors bid up prices of CRE in order to store value in hard assets?
• Will development fall off due to increases in construction costs?
• How does CRE stack up against other asset classes in a sustained high inflation environment?

While there are no easy answers, one thing is certain.  Our conventional thinking on the subject of inflation and CRE is due for an overhaul.

By Jay Marling

CEO of Capright