In light of higher, sustained inflationary pressures, investors are looking for sectors that will experience some correlation with inflation in order to both mitigate risk and in speculation that others will follow suit and drive up prices. Commodities and real estate have generally been perceived to offer inflationary protection and alignment.
However, it is not true of all real estate. You would not for instance have seen inflation correlation in the retail sector, where rents and values have been in decline due to the impact of online retailing. The COVID-19 pandemic only accelerated the trend.
The only major subset of the real estate categories to have tracked inflation over any reasonable period of time is residential. This is because residential rents follow wage inflation. The chart below shows real rents, i.e. with inflation stripped out, and the residential sector is the only one to have kept pace with the consumer price index (CPI).
Of course, exceeding inflation would be even better than tracking inflation and that is what the logistics (industrial) sector has done for the last 7 years or so. This also partly explains why many investment managers, including us at Moorfield, are increasingly focussing on the ‘beds and sheds’ sectors (residential for rent, student accommodation, healthcare, logistics and self-storage).
We also analyse demographics and societal shifts as well as the impact of technology and infrastructure improvements to gauge future tenant demand. Investor demand for ESG factors, secure and reliable income yields (and inflation linkage) are also important drivers that we target in order to deliver a combination of income growth and capital value appreciation.
Location, asset type and active asset and operational management are of course key to making successful real estate investments but at least with residential there is also the connection with inflation to help protect and improve values.
The arguments in favour of longer term inflationary pressures focus on the impact of monetary and fiscal support measures introduced by central banks and governments, along with a possible reduction in globalisation as supply chains are restructured to ensure resilience vs efficiency, thereby increasing costs, and labour shortfalls. This is the case in the UK because of the combination of Brexit and COVID travel restrictions; though it should also be pointed out that consumer price inflation is currently running at over 5% in the US compared to c. 2.5% in the UK.
In defence of a return to lower levels of inflation are the ongoing impact of technology, the ageing population and the experience pre-COVID of lower than target levels of inflation, together with a lower long term GDP growth profile.
It appears that central banks will allow some higher levels of inflation in the short term in order to avoid a derailing of the recovery, but it is of course not possible to be sure what the end-result will be, and the danger of a sustained period of high inflation for real estate will be an increasing yield profile.