Three Ways Commercial Real Estate Protects Against Inflation – Forbes Advisor INDIA

Inflation can be summarized as the decline in the purchasing power of a currency. In other words, it can also mean that the average price of a collection of goods and services in an economy increases over time.

Since the same amount of currency effectively buys fewer goods and / or services, investments intended to contribute to the growth of wealth are thwarted in their main purpose. This makes investments that are well protected against inflation all the more important. Commercial real estate (CRE) as an investment type is pretty isolated from the ups and downs of the market, but does it protect an investor from the deadly blows of inflation?

Inflation vs. Commercial Real Estate Trends

To understand why commercial property is such a resilient asset, it is essential to understand the fundamentals of that investment. Any commercial property, be it as small as a two story mall or as large as an industrial warehouse, has rental terms as its primary salvation. The lease gives the tenants not only the security of binding their business in the long term, but also the conviction that a long-term investment in it will not go wrong.

Since inflation is a time-sensitive phenomenon, long-term investments are particularly important. There have been a dozen periods of inflation in the Indian economy, but the worst cases in history were undoubtedly 1991 and 2008, when the inflation rate soared into double digits. If commercial property prices are observed over the same period, there is not only an initial slump but also a fairly rapid recovery.

Even in the uncertain times of the 2020 pandemic scenario, the commercial real estate market was one of the few investments that remained isolated from the volatility of the market and started to recover much earlier. These quick recovery times for this asset class are the main reason investors focus straight on commercial real estate.

High inflation should be on any prudent investor’s watchlist as it can seriously undervalue any investment and affect future cash flow. Investments should therefore be designed in such a way that they generate higher returns than the current or expected inflation rate. Let’s try to understand this with an example.

In a simplified way, let’s assume that the current inflation rate is around 5%. This would mean that investments in assets with a return of less than 5% suffer a loss of purchasing power each year relative to inflation. This includes even the safest and simplest investments – fixed deposits. Other safe investments such as money markets and debt can also suffer from this loss. One can only hope that the inflation rate will stabilize over the long term and that the investments will generate positive returns.

Even so, in the long run, if the investment remains unchanged, the investor’s capital can buy less because the cost of goods and services has increased faster than the returns on his investment.

To ensure that such a scenario does not occur, assets must have a higher rate of return than the current or future rate of inflation, at least insofar as the returns achieved are not negative. Inflation rates will usually continue to rise – the reasons for this are varied and complex.

The only question that remains is whether a slight rise in the rate of inflation is only temporary or marks the beginning of a prolonged rise in prices. Regardless, it is important that investors prepare to adjust their investment strategy to hedge against inflation.

Commercial real estate to protect against inflation

There are three key ways commercial property can protect investors from inflation. Let’s look at each of them individually.

Increase in rental income during inflation

Rising inflation contributes to rising prices. It is a given fact. Rising prices also include rising rents for commercial real estate. Rising real estate rents with relatively stable operating costs contribute to positive real estate values.

This can now lead to an increase in the net operating result, which further appreciates the real estate values. As long as this value is above the rate of inflation, the investor’s investment will not be hampered by holding CRE.

The leasing factor

Leases for commercial properties are structured in such a way that rents are increased at regular intervals during the rental period. For example, a contract might contain a clause that increases the rent by 2 to 3% per year.

Depending on the property and the demand and supply of the market, the clause will be different for different assets. As long as these regular increases exceed the rate of inflation, the relative return remains positive.

Real estate shortage

It’s child’s play that the space is getting smaller and smaller. As more houses, apartments and buildings are created in order to increase the supply of real estate, this also leads to a shortage of space. Companies will continue to grow and more and more companies will open, the demand for commercial real estate will continue to increase.

In dense real estate markets and commercial centers, high demand and limited supply contribute to the appreciation of real estate prices, which is positive for investors. So when the price increases exceed the rate of inflation, the relative return remains mostly positive.

Invest in commercial real estate

The biggest problems encountered when considering investing in commercial real estate are ticket size and the lack of information about the asset class. What to look for, where to invest and which potential markets to look out for?

For your inflation protection strategy, there are three ways you can start investing in commercial real estate:

Ownership shares

The main benefit of partial ownership is that it reduces the ticket size of the investment, giving retail investors the opportunity to get into commercial real estate. Fractional ownership allows portfolio diversification and you are free to choose the asset you want to invest in.

Purchase of REITs

Real Estate Investment Trusts or REITs are companies that deal with the purchase, management or financing of real estate. Although they allow diversification, they also save you the hassle of the countless formalities and legalities when buying real estate. Here, similar to a mutual fund, you can choose the REIT, but not the individual assets in which it is invested.

Buy CRE directly

Last but not least, you have the option of owning or co-owning a commercial property. Here, however, you need to have a thorough knowledge of the market in which you want to invest and also take care of all the formalities, legalities and operating costs of the property. This is a better option for those who have long known a market, have adequate funds to invest, and are not looking for a quick, convenient route to exit.

Bottom line

Although the reasons are convincing enough, how do you start investing in CRE? Understanding the market is an important aspect that you need to consider supply and demand, market forecasting, and asset due diligence.

To make investing with CRE better and more hassle-free, you can either research CRE directly and invest in CRE if you have the time, resources and expertise to invest through REITs, or you can choose the fractional ownership route that the Load of. reduces the ticket size required for investing in commercial real estate while taking care of the legal aspects, formalities and due diligence when investing in CRE.