Can real estate hedge against inflation?
With a surge in inflation, the value of an investment can decrease over time. It is therefore prudent to develop strategies which hedge against rising prices and ensure that an investment portfolio is able to thrive.
Whilst real estate is often referred to as a good inflation hedge, there is no clear correlation between inflation and real estate returns, as the induced impact will depend on the cause triggering inflation. Indeed, if demand-driven inflationary pressure are benefiting commercial real estate returns, supply side pressures (similar to the current environment) are more difficult to hedge for investors.
Real estate: the best option in the current market
The capabilities of each asset class to deliver higher returns than inflation is important for investors. Indeed, the higher the certainty of generating a positive real return over a certain holding period, the more appealing the asset class is for investors. Across Europe, real estate is able to provide positive real returns earlier than equities (five years for real estate vs 11 years for equity).
Fixed income also appears to have strong hedging capabilities against inflation. However, in the current context and with current negative real yields, real estate will likely be the best option for investors to protect themselves against inflation.
Building an inflation-hedge real estate portfolio
Real estate has a competitive advantage compared to other asset classes as rental values are often indexed to inflation. However, market rental values must follow inflation in order to have a good hedge against it, meaning that investors should carefully select assets based on the local economic environment and sectorial dynamics.
For rental values to follow or even to outperform inflation, the market needs to be under supplied and the economic environment strong for tenants. Signs of a constrained supply are a good place to start when looking at inflation hedging assets, as the mismatch between supply and demand enable rental growth to outpace inflation over long periods. Well-located offices for example, will likely continue to experience a strong level of rental growth, thanks to a limited supply and high-quality demand. Sectors driven by strong demand (logistics, residential and retails parks) should also be able to offset potential losses from inflation.