Inflation is the rate at which prices of goods and services in an economy, such as the U.S. economy, rise in a specific time period. For investors, inflation comes with many different advantages and disadvantages.
Additionally, multifamily has seen a historic increase in rent nationwide. Many of the key drivers of inflation, higher residential home values, higher mortgage costs, and wage growth, are largely the cause. Because the costs to purchase a home has gone up dramatically, many people have been priced out of the market and are renting for longer.
Inflation has recently been a concern for most Americans, as rates have nearly reached unprecedented levels. With the current high rate of inflation, it can negate any interest earned on investments making it challenging for investors to yield profit.
During these inflationary periods, it’s important to diversify your portfolio because concentrating all your assets into one area may be susceptible to volatility. A well-diversified portfolio of investments spread across different asset classes and industries can protect you from risk.
TIPS FOR WISE INVESTING IN COMMERCIAL REAL ESTATE IN TIMES OF INFLATION
6 important things to note when investing in commercial real estate amid inflation are;
1. Researching a Property
In general, the first step with any commercial real estate investment is research. This means looking at the property itself, as well as the surrounding area. Key things to remember include legal due diligence, making sure all the paperwork is in place, and performing a good recce of the infrastructure in the area.
There are a number of online tools that can help you with this research. You can also talk to a real estate agent to get more information about a specific property. If you have the option, also think about investing in different types of properties across other locations. While diversifying your portfolio, will also help you bear even less risk if any of the areas suffer from stagnant demand at any time.
2. Understanding the Marketplace
When looking at assets to invest in, take a good look at the marketplace. Is it a seller’s market or a buyer’s? In times of high inflation, the economy is usually riding on a high and it is possible that properties are being traded for rates far higher than they are worth.
Take time to do the math. If you bought the property, what’s a reasonable rate you could lease it out for? If the rental yield is too low, then you spent too much on the property. An alternative to deploying all your money in a single property is to opt for Real Estate Investment Trusts (REITs) or fractional ownership. There is one major downside to REITs in the sense that you do not get the choice of your preferred property. In fractional ownership, you can choose how much to invest in any property of your choice.
3. Include a Commercial Lease Rent Escalation Clause
When you include a rent escalation clause in the lease agreement of your commercial property, it’s a solid way to hedge against inflation. There are a few general methods you can use to increase your commercial real estate rates with a rent escalation clause. These include:
- Percentage escalation
- Fixed escalation
- Consumer price index escalation (CPI)
Since the increase in rent is based on the consumer price index, CPI escalation will be fixed to inflation directly. Landlords can maximize the profit they earn through CPI escalation clauses when inflation is high.
4. Adjust Your Current Investment Strategy
As inflation rises, you may want to take a closer look at your strategy to ensure you’re making the most out of the current climate. For example, if you were previously flipping one property after the next, you may find it helpful to hold onto these properties rather than trying to sell right away.
With record-high interest rates (now exceeding 7% for a 30-year mortgage), many buyers aren’t willing to pay higher purchase prices. As a flipper, this may cut into your profit margin for each sale, as the goods you may need to purchase to perform the flip (e.g., appliances, flooring, paint, lumber) may also be more expensive as a result of inflation. However, if you hold your property and rent it out, you may be able to earn some passive income while having the mortgage paid over time by your renter.
5. Increase Tenant’s Operating Expenses Share
As inflation increases, the cost of operating a commercial building generally increases. With a commercial lease arrangement, the tenants usually have a pro-rata share of operating costs. This share is based on how much square footage is occupied by the tenant.
To ensure profits and stay ahead of the curve, landlords are able to raise their share of the operating expenses of the tenants. These expenses typically include:
- Real estate taxes
- Building maintenance
However, expenses like these must be identified clearly in the lease with an escalation clause, letting the tenant know there may be potential rate increases.
6. Diversify Your Portfolio
Even in a normal market, having a range of investments and strategies helps ensure you have a constant cash flow in case one of your strategies doesn’t meet your expectations. In times of high inflation, having some backup options is even more important, as opportunities may require more effort to find.
Here’s how you can diversify most efficiently:
By asset type: This would involve investing in different kinds of real estate that help make up for macroeconomic changes, such as the shift from office spaces to remote work. Some asset types include:
- Small multi-family properties
- Large apartment complexes
- Retail & industrial or cooperative spaces
Geographical location: Location is one of the most important factors in real estate investing. You can potentially protect yourself against economic swings by spreading your investments across different sectors. Before picking a location, you should consider areas that have:
- High job growth
- Population growth
- Job diversity
Asset class: Recognize that people’s housing preferences change with the economy and culture, from larger, more luxurious homes in good times to smaller, more modest homes in harder times.
Active and passive investing: An effective inflation hedge may be made by either active real estate investments (such as rental properties) or passive real estate investments (such as group investments).
Intelligent, informed investors often invest in real estate investors as a way to diversify their portfolios and hedge against inflation so that they can better ride the ups and downs of inflation trends. However, keep in mind that no investment strategy is a guarantee. The current inflationary environment could present an opportunity to invest in a lucrative long-term asset. Just be sure to do your homework and consult with a financial advisor before making any decisions.
As informed investors we should understand the risks associated with real estate investing and that there is no guarantee. Please do your due diligence.
Contact Estateserve today and realize your cash flow goals.
Tips for wise investing in commercial real estate in times of inflation
- Researching a Property
- Understanding the Marketplace
- Include a Commercial Lease Rent Escalation Clause
- Adjust Your Current Investment Strategy
- Increase Tenant’s Operating Expenses Share
- Diversify Your Portfolio
Why is commercial real estate a good hedge against inflation?
Commercial real estate is a good hedge against inflation because it provides a physical asset with long-term value. Additionally, the rental income generated from commercial properties can help offset the impact of inflation on other investments, such as stocks and bonds.
What are the risks associated with investing in commercial real estate in times of inflation?
There are several risks associated with investing in commercial real estate in times of inflation, including rising interest rates, increased competition, and changes in market conditions. Additionally, changes in the economy, such as recessions or downturns, can also impact the value of commercial real estate investments.
How can investors minimize the risks associated with investing in commercial real estate in times of inflation?
Investors can minimize the risks associated with investing in commercial real estate in times of inflation by following the tips outlined in this article, such as diversifying their portfolio, investing in properties in stable markets, and seeking the advice of a professional commercial real estate advisor.