How the Real Estate Sector Benefits During Inflationary Economic Period


How the Real Estate Sector Benefits During Inflationary Economic Period

US — During high inflation periods, most sectors of an economy would be greatly affected detrimentally. This is especially true in the US as we witness right before our eyes how the first half of the year unfolded — record-breaking inflation rates, which currently stand the highest in all of the developed economies. Thus, many US companies in multiple sectors have reported worse financial results as costs generally went up this year. Nevertheless, the US Federal Reserve (Fed) continues to aggressively curb this inflation by implementing tightening monetary policies that so far have not stopped inflation from rising.

Therefore, it begs the question, is there a sector that could be an outlier during this challenging economic landscape? The answer to this could be a handful of select sectors with niche specialization. However, just around the corner, there could be a more apparent winner that hides in plain sight. A sector that does not shun upon the effects of the rising inflation and instead fully embraces it and even takes advantage of it.

Inspired by Marc DeLuca, CEO of KBS — one of the most prominent investors of the premier commercial real estate in the US, in this article we will take a closer look into the Real Estate Sector.

What Makes the Real Estate Sector Special?

First of all, the US real estate sector has historically outperformed the US stock market’s return during high inflation periods. Thus, both retail and institutional investors have seen real estate as a “hedge” asset to reduce the market risk during this dreadful economic cycle by diversifying in this sector.

“In 1946, a post-war rise in consumer goods spending and pent-up demand for celebration led to inflation soaring to a whopping 20%. Inflation rates also crested during the late 1970s … of course, more recently, in 2020, the pandemic caused a rise in unemployment and many businesses to fail,” DeLuca said.

He added, “… all of these situations righted themselves in the end.” DeLuca argued that we should not be alarmed by the current high inflation rate in the US as, historically, the inflation rate will soon subside and return to normal levels.

“Higher inflation for a shorter time is generally good for real estate. Analysis at Cushman & Wakefield shows that every 1% increase in inflation is associated with a 1.1% increase in total returns to investors, including REITs, pension funds, and individual investors.”

The Demand is Holding Up

The demand for property assets, especially Commercial Real Estate (CRE), has not dwindled despite the tightening policy the Fed is currently implementing. Moreover, this push-pull economic environment created by the central bank could even be an advantage to the sector on top of the rising inflation alongside it.

“Growing interest rates evoke a double-hedge effect where financing costs become higher, especially in construction, meaning there is a less new product on the market,” DeLuca remarked. This would ultimately cause the valuation of the existing real estate assets, especially CRE, to remain firm as demand for existing properties remains strong.

The unique position of the real sector has even enabled it to weather the outside forces contributing to the difficult economic environment in the US. “Burgeoning labor costs [including rising gas prices] and supply-chain issues are limiting new development, which benefits existing properties,” said DeLuca.

Ultimately, this provides an avenue for investors to consider taking a look into property stocks with solid fundamentals as well as local real estate properties that could provide an alternative income source while maintaining their intrinsic value and market demand during this uncertain period.

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