How is Commercial Real Estate Seen as an Inflation Hedge?

Commercial real estate is often viewed as an inflation hedge due to its physical nature and the potential for asset value appreciation. When the money supply increases during periods of inflation, the prices of all types of assets, including commercial real estate, tend to rise. This stable and tangible property can help protect investors from the deteriorating purchasing power of currency.

Landlord’s Advantage in Raising Rents

Commercial properties have long been considered a valuable inflation protection because landlords of many property types can raise rents to outpace price increases. This capability makes rental apartments and self-storage units particularly well-suited to a rising-price environment, as their rents typically reset annually.

Other Factors Influencing Real Estate Value

While the hike in property prices is closely tied to inflation, other factors also play a significant role. Real estate prices often reflect the combined effects of inflation and population growth, as well as the increasing demand for housing. For instance, new construction costs rise due to higher prices of components like framing, roofing, and appliances. This trend increases the cost of new homes, which in turn raises the value of existing homes that are comparable in terms of size and location.

New Developments Accelerate Housing Demand

The emergence of new developments, such as a new headquarters or a university campus, can significantly boost housing demand. Take, for example, a location near a new Amazon headquarters and a large university campus attracting thousands of students and support personnel. This influx of people not only increases the demand for housing but also raises prices. Additionally, the addition of infrastructure, such as a new subway stop, can further stimulate the market, driving up property values.

Real Estate as a Hedge Against Inflation

While the value of housing is an important factor, it's crucial to consider the additional leverage from mortgages. Investing in a property with a mortgage can offer substantial returns, especially when compared to inflation rates. For instance, if you buy a $200,000 house and experience a 5% inflation, the house’s value would increase by $10,000. With a down payment of 20%, your initial investment of $40,000 would yield a 25% return, and with just 5% down, a 100% return would be possible.

Rental properties also offer potential for income growth, although they require careful management of cash flow. By selecting the right properties, landlords can ensure that tenants pay enough to cover expenses, thus achieving positive cash flow. Additionally, there are tax benefits associated with owning a rental property, which can further enhance your investment returns.

However, it's important to recognize that the real estate market is not without its challenges. The current economic landscape is being affected by factors such as the pandemic and government policies, such as rent waivers, which can impact the stability of rental properties. Despite these challenges, commercial real estate remains a viable hedge against inflation, offering long-term stability and potential for growth.