Commercial Real Estate as a hedge against inflation

This article is about inflation and commercial real estate investments. Is it safe to invest in commercial real estate in rising prices periods? Is this type of investment a great hedge against inflation?

Rising prices worry all investors and create uncertainty in all financial markets. Some investments are safer when we expect to raise interest rates. When inflation rises, there is a general increase in the price in many asset classes.

When inflation rises, it is correct to adjust your investment portfolio. Buying tangible goods and differentiating is the main rule.

Related article: Inflation and real estate: should you buy a home?

Is it better to choose a commercial real estate investment or buy a residential home? We are talking about buying properties to collect rent. 

We come from a long period of low inflation, but things could change, and many analysts alert investors. Real estate prices are very susceptible to inflation, and we can see bubbles in the housing market.

house price index bubble chart - 2021
Image from WolfStreet: Link

The Federal Reserve could initiate a rate hike policy to deal with a now evident high inflation.

Central banks around the world behave pretty similarly. A rise in inflation in the United States will cause the Federal Reserve to make decisions, followed by other central banks.

COVID-19 and the subsequent rise in government debt suggest that the price of goods and services could rise. Short-term hyperinflation may occur, but a long-term rising inflation period may also begin.

When prices increase, how could commercial real estate react? Let’s analyze some aspects together to make an informed investment choice.

Rising prices and commercial real estate

The first aspect to consider is the increase in the price of commodities. Economically, the commodity’s prices increase causes the economy to slow down because it increases costs for companies. The higher costs will lead to higher prices for final consumers and, therefore, lower sales.

The consumer price index measures the weighted average of prices of a basket of consumer goods and services.

consumer price index components with housing

As you can see, an essential part of the consumer price index concerns the real estate market and housing prices.

New business projects become more expensive and are postponed in inflationary periods. All this will affect commercial real estate both positively and negatively.

Inflation’s positive impacts

The most significant positive impact is that real estate builders will build not many new commercial properties. 

Therefore, existing properties will appreciate because there will be less supply on the market for an extended period of time. 

Buying a commercial property with a long-term fixed-rate mortgage gives us an advantage against the effect of inflation.  Rent prices increases will make the long-term fixed-rate mortgage increasingly advantageous.

Businesses that require business assets will choose to rent them during the period of high mortgage rates. 

An entrepreneur will also prefer renting rather than buying by the period of economic uncertainty due to inflation. In commercial real estate, it is easier to renegotiate term leases and adapt to rising inflation.

All this should provoke an almost certain generalized rent increase. It is important to prefer to rent for short periods to adjust the prices to the rising inflation. 

commercial rent growth chart 2021
Image from Reit.com: Link

Those who are invested in real estate will have a higher annual rate than other investments. The cash flow generated by the rents will abundantly cover the cost of the mortgage.

The more rent prices rise, the more affordable our low-interest mortgage will become. In this article, we do not consider the purchase of commercial property for the conduct of its business. We will only analyze the buying with the mentality of a short or long-term real estate investor.

Inflation’s negative impacts

Unfortunately, when prices rise, fewer entrepreneurs decide to invest in new businesses.

The economic contraction and rising prices will lead to a lower economic availability on private individuals in the high inflation periods. Purchases will drop, and many businesses will find it challenging to stay open. Many commercial real estates will remain vacant while mortgage payments will continue to be charged.

The rise in consumer prices will impoverish private individuals, and therefore all real estate assets will suffer. 

High consumer prices cause lower-income and unemployment, which is why central banks are so careful to keep inflation under control.

However, the Federal Reserve often cannot intervene aggressively because, as in the post-covid crisis, the crisis factors are manifold.

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