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With inflation reaching a higher-than-expected 8.3% year-over-year rate in August, more investors are discussing commercial real estate (CRE) as a hedge against inflation. The consumer price index (CPI) increased by 0.1% in August, while the core CPI (which omits the more volatile food and energy indexes) increased by 0.6%, making greater gains than it had in July. To measure inflation, the Federal Reserve (the Fed) prefers to use the personal consumption expenditures (PCE) index, which has also posted year-over-year gains, in the amount of 6.3% as of July. To curb inflation, the Fed has instigated five rate increases in 2022 as of September 21, with the last three at 75 basis points each.

During their August meeting in Jackson Hole, Wyoming, Fed Chair Jerome Powell announced an intent to continue an aggressive bid to reduce inflation, even as such measures “bring some pain to households and businesses,” arguing that “failure to restore price stability would mean far greater pain.” At the most recent rate increase, Fed press release notes the Committee “anticipates that ongoing increases in the target [rate] range will be appropriate.”

With the stock markets sustaining fresh shocks amid what seasoned investors are calling classic bear market rallies, investors continue to turn to CRE as a hedge against inflation since it can allow for long-term, steady income, including lease terms that may adjust to CPI.

A hesitancy to overbuild has, in the past decades, generally led to greater demand than supply. Lately, the volume of new construction has rebounded, reaching a 14-year high in July, and while the August figures declined slightly from the month prior, they still represented a 14% year-over-year increase. With the rise in interest rates and weaker economic conditions, new construction starts are expected to slow in the coming months, once again placing upward pressure on the values of existing inventory.
For these reasons, it may not be surprising that the volume of CRE investments rose 10% year-over-year in the U.S. Additionally, foreign investments in U.S. CRE have increased by 13% this year. Clearly, those with the liquidity continue to seek favorably positioned assets.
How well an asset is positioned to withstand inflationary periods, though, depends on several factors: the asset type, its location, and the timeframe of the investment.

As a hedge against inflation CRE investments are most beneficial longer term—in the range of five years or more—ideally as part of a larger and varied portfolio; while as a short-term investment, CRE is often misunderstood. CRE can be susceptible to inflation shocks and increases to operating expenses that may not be able to be passed off to a tenant or recouped in rent increases, depending on the asset class and location. While it can be a solid investment strategy in times of high inflation, it is important for investors to “ensure they don’t undervalue the investment or fail to capture future revenue.” And, as in other asset types, maintaining a diverse portfolio remains a strategic move.

Since the impact of inflation on each of the main CRE property types—multifamily, industrial, office, retail, and hospitality—is varied enough to warrant its own post (and truly, each could warrant a post on its own) we’ll cover these in Part 2. There we’ll summarize key trends for each property type, touching on aspects like development, supply and demand trends, lease structures, and revenues.