Real estate is often quoted as being a good place to invest when inflation levels are high. This is because rents can be highly correlated with inflation, some leases even have contractual inflation-linked uplifts. However, it is necessary to dig deeper into which subsectors have actually delivered this over the long term. In the UK, office, industrial and retail rents have in fact not kept pace with inflation over the long term, whilst residential rents have.
But what about capital values? Rents may be rising but if interest rates are also lifting to combat inflation and as a result valuation yields also increase, then values could come under pressure. This is likely to deliver a double whammy effect – property types where rents are not rising are going to suffer the biggest yield movement, depressing values the most, and properties with rising rents will continue to attract investor interest, especially if the alternative options for inflation protection are limited.
Residential values may not continue to rise as fast as they have been to date if mortgage costs rise and the cost-of-living pressures dent general affordability further. However, this is likely in turn to increase demand for renting. This also comes at a time when the attractions of being a buy-to-let investor are waning due to the impact of losing mortgage interest tax relief / higher stamp duty / EPC requirements etc. This may also lead to reduced availability of rental accommodation that the nascent BTR market will struggle to address on its own (there are still only c. 70,000 completed BTR units compared to c. 5 million renters in the UK).
This is why our latest fund, MREFV, for which we secured £270 million of commitments in a first close earlier this year, will be investing in houses, flats and HMOs that already exist, with a view to improving the rental experience. We are doing this by investing in the homes and improving both energy performance metrics and customer service. There is also less build cost risk, another area where inflation is biting and will restrict new supply, and it must be better for the environment to improve and transition existing homes rather than build new ones. We also think student accommodation, nursing homes, logistics and self-storage, where there are structural and needs-based drivers of demand, will offer the best investment opportunities.
Brexit, release from COVID-lockdowns, the conflict in Ukraine, re-shoring and net zero carbon commitments, may all be contributors to inflation. However, the massive monetary and fiscal stimulus from all central banks, that has pushed up the money supply, is probably the key underlying driving force behind the current inflation levels. This means that central banks have already made their policy mistake because QE continued despite COVID-lockdown recovery and very low levels of unemployment. Now central banks are acting by raising rates and easing off the printing presses.
However, it seems unlikely that central banks will want to cause a recession and will likely prefer inflation over job losses. One way or another, we have to pay at some point for the debt raised to deal with the GFC and COVID – inflation may be chosen as the least painful way to do so.
Picking the right property types and paying the right price is always important but as the tide goes out this has become critical. Fortunately, disruption and uncertainty also creates opportunity and for those with capital to invest the next few years could turn out to be a great vintage.
https://www.costar.com/article/721367039/inflation-%E2%80%93-is-real-estate-a-good-place-to-hide