By Nicholas Leider
BUILDING PRESSURE
Commercial real estate can be an effective hedge against inflation , which is a pressing concern amid current economic conditions .
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Whether the average person is a rational actor within an economic system is a question that a few centuries of debate have yet to answer . But in 2022 , with all kinds of complications facing commercial real estate , it ’ s easy to get caught up in the news of the day and lose sight of the forest among the trees . Inflation is one such topic of intense interest for commercial real estate .
To provide some much-needed context to the conversation , Commercial Investment Real Estate spoke to Martha Peyton , Ph . D ., managing director and global head real assets research at Aegon Asset Management . Long considered a hedge against inflation , commercial real estate continues to face challenges in the face of COVID-19 and the war in Ukraine , but opportunities are available in all property sectors for smart , knowledgeable investors .
CIRE : CONSIDERING COMMERCIAL REAL ESTATE HAS TRADITIONALLY BEEN SEEN AS A HEDGE AGAINST INFLATION , WHAT IMPACT DO LARGER ECONOMIC TRENDS HAVE ON CRE ?
MARTHA PEYTON : Commercial real estate starts to grab headlines as a hedge when inflation starts to jump , so it ’ s very much expected and very rational that investors are asking that question again . What investors tell us when we ask them in surveys about interest in commercial real estate , the No . 1 attraction is its diversifying power — and I don ’ t think this has changed . But the potential to hedge against inflation is also something that makes CRE attractive at times like these .
Looking at CRE and inflation , I want to go into the real estate part of the question rather than inflation . If an investor can look at historical performance and empirical analysis , has the investment class traditionally beaten inflation ? You can look at it strictly in terms of historical data , and when you do that , you come away feeling pretty good that commercial real estate is an effective inflation hedge . But if you ’ re a more curious investor , you are going to think about why — and you are going to look for the structural characteristics of an asset class that underpin its capacity to serve as an inflation hedge . What you ’ re going to find there is that the lease structure of some sectors is very effective to hedge inflation . If a lease structure provides step-ups , where the rent is going to inch up periodically in an amount determined by the official inflation rate , that ’ s pure gold as a hedge . You ’ re going to see hedging capacity when you have rents that pass on common expenses to tenants , so-called CAM expenses such as fuel costs or higher property taxes .
You ’ ll also see inflation hedging capacity when leases are relatively shorter in term , which is common in the multifamily sector . Where you ’ ve got one- and two-year leases , when these expire , you can reset rents to cover whatever inflation has transpired or is currently transpiring . But the really , really important thing to put on the table is that real estate investing can only prove to be a hedge against inflation in markets and sectors that are balanced . If you ’ ve got a sector in a particular location that ’ s way overbuilt , you need to be tracking the relative supplydemand balance in sectors and markets .
CIRE : WITH THE MIXED PERFORMANCE OF DIFFERENT SECTORS IN THE WAKE OF COVID-19 , I WOULD IMAGINE THAT INVESTMENT DOLLARS WOULD FLOW TOWARD MORE STABLE AREAS OF CRE , LIKE INDUSTRIAL AND MULTIFAMILY VERSUS RETAIL AND OFFICE . IS THIS A CORRECT ASSUMPTION ?
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