The Monthly Multiple — Commercial Real Estate News: September 2021
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The total returns of privately held property and infrastructure assets globally have beaten those of main stock and bond indices when inflation has exceeded 2.5%.
The most recent forecast released by the Fed predicts core inflation of 2.3% in 2022.
The BlackRock Investment Institute sees inflation in the 3% range in 5 years.
New Perspective on a New Asset Landscape
Where has the time gone? It has been roughly a year since the economic recovery began. Another month, and inflation remains top-of-mind at EquityMultiple and for many industry-watchers.
In the practice of monetary theory, historical precedent often provides a sample size countable on one hand (if that). Perhaps with the experience of the post-Financial Crisis recovery in mind, the Fed seems hell-bent on a dovish tact, avoiding clamping on the brakes and watering down the recovery. This would seem to make two outcomes likely:
- Inflation continues, particularly as tight labor markets, out-of-whack supply chains, and rising input costs drive up prices in some sectors.
- Money should remain cheap; good news for real estate investors on the make.
A recent Blackrock study puts average inflation at just under 3% from 2025–2030 — not the bloodbath of the late ‘70’s, but enough to shake up asset allocation strategy. As the authors note, waiting until a period of consistent inflation to adjust asset allocation generally proves to be too late. History shows that total returns of privately held property and infrastructure have beaten those of core stock and bond indices when inflation exceeds 2.5%*. In the case of real estate, this tends to hold true because rents track to overall price movement and labor market tightening while property values track to the balmy economic conditions that produce inflation. Hence it’s no surprise that major institutional investors are shifting ever greater allocation to alternative assets.
However, in the coming years, private-market real assets may not be spared by the sort of macro shocks that have already introduced greater volatility into public equities markets. Pandemics, tech disruption, and climate change may create more frequent and unpredictable stress on asset prices.
The takeaway for real estate investors: varying your portfolio across hold periods, structures, operators, geographies, and risk profiles is more important than ever. The recent launch of our diversified notes — a modern alternative to savings — provides a new arrow in the quiver for diversification-minded investors. These notes carry 3, 6, or 9-month terms, with reinvestment options, potentially offering cash management flexibility, a new wealth-generation tool, and liquidity to stay nimble and take advantage of opportunities as they arise.
The Potential Impact of Tax Code Changes
Inflation carries major implications for long-term net investment returns. So does the tax code. With an increase in long-term capital gains tax rate on the table, investors may consider the relative tax treatment of individual assets within their real estate portfolio. Profit realized on real estate equity investments is taxed at the long-term capital gains tax rate, whereas interest on debt investments and other cash flow is typically taxed at the (historically higher) ordinary income tax rate. However, the potential for interest rate increases caused by inflation expectations makes it prudent to keep your maturities short. Shorter duration amongst fixed-income investments in real estate may help hedge against inflation risk. Again, our alternative to savings products could provide a great starting point.
The appreciation upside of CRE equity investments may also shine through during inflationary periods; whereas a savvy sponsor or developer can exit at an optimal moment in terms of asset value, rents (and hence NOI) may lag inflation by months as operators restructure leases. These increases over time accrue not only to the value of equity positions, but also to the protection of debt positions as increased cash flow covers debt service payments by a wider and wider margin. All this to say: at a moment when both sustained inflation and some form of tax code changes are likely, diversifying across the capital stack may provide substantial benefit real estate investors.
BlackRock — Inflation & Real Assets
The Guardian — Global supply chain issues could spell stagflation
The Economist — Do physical assets shield investors from inflation?
“Where possible, focus on shorter leases; focus on sectors with shorter lease terms such as hotels, (US) apartments and self-storage. During periods of higher inflation, this allows for rents to mark-to-market more often, thus benefitting the investor.”
Originally published at https://www.equitymultiple.com on September 29, 2021.