Inflation refers to the increase in prices of goods and services. It is generally measured by the CPI (Consumer Price Index) which analyzes the increase in prices in various subjects like ‘Food’, and ‘Energy’.
Inflation is caused by several factors like; 1) an increase in the circulation of money 2) an increase in cost of production (materials and labor), and many other factors like an increase in demand.
An increase in inflation, ultimately means a loss of buying power.
Supply and Demand
When the general costs of materials and labor increase, it impacts development costs which can ultimately slow down new construction and limit the supply of inventory. Because of this, existing inventory in high demand can experience increased rents and values, like we saw with Multifamily and Industrial assets in 2021.
Disrupts Values and Cash Flows
With rising costs of labor and materials, NOI can be negatively affected due the increase in operating expenses. Although, when inflation is highly affecting the operating cost of commercial real estate, this can demand an increase in rents, which depending on the demand for the asset type, can ultimately lead to a positive impact on the NOI making the asset more valuable.
Impact Varies by Asset Class and Project Types
The level of impact from inflation varies by Asset Class and Project Types. Assets with longer term leases are less likely to increase rents when their operating expenses increase. Assets like Storage Units or Multifamily have shorter term leases which allows for sooner rental increases.
Project Types like acquiring a stabilized asset versus ground up developments are also impacted much differently based on the demand for the asset class, and the increased cost of development.
Conclusion
Commercial Real Estate is proven to be one of the greatest hedges against inflation as it holds intrinsic value and provides dividends from rental income. Since inflation pushes prices up, asset prices tend to follow, and so do rents.
With rising inflation and compressed cap rates, it is important to look for yield but also not fall into the trap of over paying for an asset. We are seeing this happen now, and it is not going to end well for those who do.
We continue to follow our principles and seek growth opportunities, all while controlling the risk.
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