High inflation rates are likely to be advantageous for allocations to real estate as they will neutralise any supply-side issues and boost the residual value of improvements, according to a boutique investment manager.
“We take the view that investors shouldn’t fear inflation, particularly when it comes to real estate,” Quay Global Investors portfolio manager Justin Blaess said.
“Investors in real estate – both direct and listed – can therefore benefit from a higher inflation environment, particularly compared to global equities investments.
“Because of supply constraints, well-located land will generally appreciate over time. In addition, the cost of replacing any improvements built on the land will also increase through inflation. This is significant, because if there is excess demand for a type of real estate, the market will have to accept rising costs and thereby the rents required to economically justify construction – regardless of the inflation environment.”
Further, these reasons mean property will outperform equities in a high inflation environment, he said.
To prove this point, and to measure how real estate performs through varying levels of inflation, Quay analysed the real and nominal returns of United States real estate investment trusts and the S&P 500 by constructing indices for when the headline consumer price index was both less than and greater than 3 per cent and in increasing increments of 1 per cent.
“Our analysis shows that listed real estate is an excellent hedge for inflation and has historically delivered strong positive nominal and real returns in higher inflationary environments. It also offers a better relative return when compared to general equities,” Blaess revealed.
“This is especially so when inflation is in the moderate 3 to 6 per cent range, where listed real estate has historically generated more than double the real return relative to equities.”
As such, he encouraged property investors to take a long-term approach and not to fear inflation.
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