Commercial property prices are driven by many factors. One of them is inflation. The DWS Group’s experts are convinced that their development does not speak against these properties at the moment.
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Milton Friedman once warned that “inflation is a monetary phenomenon anytime, anywhere”. More than 50 years later, the US Federal Reserve is apparently putting this claim to the test: it has almost doubled its total assets since the beginning of the Covid-19 pandemic.
Inflationary consequences are probably harmless
The DWS assumes that the inflationary consequences will be relatively harmless, as they will be kept in check by the weak labor markets and an orderly reduction in monetary policy incentives. Even Friedman, in the further course of his famous lecture, weakened his thesis that goods and services prices must inevitably rise as a result of higher monetary growth. Nevertheless, there is price pressure on the raw material markets (e.g. oil, copper and wood), especially compared to the low previous year’s figures. It’s hard to deny that the massive fiscal aid programs being monetized by the Fed could overheat the economy, especially if the supply side can’t keep up. A recent example is the acute semiconductor shortage eating its way through the supply chains of many industries, including automakers, which could drive up some retail prices. The implied inflation rates seem to reflect these concerns – they have been rising steadily for several weeks.
Inflation protection is justified in times like these
Even if sustained inflationary dynamics are not a foregone conclusion, today’s extraordinary macroeconomic environment certainly calls for at least some inflation protection. Various options are available to investors, such as inflation-protected bonds and commodities. In the past, investors have also relied on real estate. As the following DWS chart shows, US real estate showed a strong correlation with inflation, especially in the 1970s and early 1980s.
Inflation and commercial real estate
From 1971 to 1985 consumer prices rose by an average of 6.5 percent and commercial property prices by 7.8 percent (with a correlation of 0.76). From 1961 to 2020, on the other hand, consumer prices rose by an average of 3.3 percent and commercial property prices by 4.6 percent, the correlation was only 0.36.
The correlation is not perfect
This is because other factors, such as secular forces (e.g. demographics or online trading) or interest rates also play an important role. But rents typically react positively to inflation, since on the one hand the higher-income traders increase nominal demand and on the other hand higher construction costs limit supply. Over time, property prices approach replacement costs, which are directly tied to inflation. In any case, commercial real estate is worth a look as a potential hedge should inflation fears escalate further, say the experts at DWS Group. (kb)