From a historical viewpoint, it is clear to see that there is a cause-and-effect relationship between inflation and the commercial real estate sector. Most often, higher interest rates (inflation) directly correlate to lower property (commercial real estate) values. This is not always true, since increasing interest rates may be indicative of a growing economy and a demand in real estate. In this article, we delve deeper into inflation and how it relates to the commercial real estate sector.
Examining What Inflation Means
Inflation is an economic term that can be defined as an increase in general prices while there is a decrease in money’s purchasing value. In everyday terms, this refers to higher costs you will have to pay for ordinary grocery expenses while not receiving a bump in your income to help offset these costs. Inflation is a rate of measurement where the average price of a select amount of goods and/or services increases over a given time period.
It is frequently shown as a percentage and indicates a lower level of purchasing power of a country’s money (or currency). People use inflation to rate how the economy is performing. There are different viewpoints as to whether it is a good or bad sign. Some individuals view it as a sign of an economy that is thriving while others are concerned with the higher prices.
Investing in Commercial Real Estate
The commercial real estate sector refers to non-residential properties that are only used for commercial purposes. These typically include shopping centers, apartment complexes, office buildings, etc. These properties have many tenants usually, so there is less risk for an investor since they are not relying on only one tenant for their rental income.
The following are some of the most attractive features of commercial real estate investing:
1. Tax benefits such (e.g. depreciation)
2. Control of a tangible asset (unlike stocks)
3. Liquid capital markets to be used for financing purposes
Among the main differences in commercial versus residential real estate investing is that most commercial real estate investing is done by professionals who are specialized in the area. This is in comparison to the numerous rental property owners who choose to use their own non-professional knowledge to decide on which properties to invest in. This usually leads to a higher level of loss.
Relationship Between Inflation and Commercial Real Estate
The relationship between how well commercial real estate properties perform and inflation is dynamic. When inflation causes prices and wages to rise, historically rents and values have risen. The values of commercial real estate most often are based on net incomes, so rents and expenses should also increase or rise with inflation. Oftentimes, expenses will increase quicker than income.
Inflation will sometimes cause the Federal Reserve Bank (or Fed) to decide on increasing short-term interest rates which indirectly has an effect on long-term rates as the Treasury yields spike. The increases in capital costs generally produce increased capitalization rates and are counteractive to any increases there may be in income. Rising interest rates can have great impacts on commercial real estate values which can cause real estate investors to have a fear of falling property values to fall sharply.
Commercial real estate is widely believed to be an asset class used to offset inflation’s impact on a long-term period of time. This is one of the benefits of investing in commercial real estate. Most academics and financial service advisors agree that private commercial real estate can be a hedge (at least partially) against increased inflation. Being able to adjust your rents is generally credited for these inflation-hedging advantages. In general terms, strong overall economic growth will result in increased inflation and higher growth in rent as well.
Let Us Help You Invest in Commercial Real Estate
Landwin Commercial Real Estate, an Encino-based real estate investment firm, has several decades of successful experience managing industrial, retail, and office, properties in Los Angeles and surrounding areas. You should always have a professional company such as Landwin Commercial Real Estate handle all operations and management of commercial real estate. This will allow you, the investor, to receive passive income and let your money work for you.