How Does Real Estate Act as a Shield Against the Burgeoning Global Inflation?

Josy Mathew, MD and CEO, LIvvehomes.com says, “Majority of home buyers became super active Home buyers who were slowdown-proof and recession-proof were least affected during the Covid pandemic. As a matter of fact, they became a catalyst to the recovery of the housing market, as they could afford bigger houses post the pandemic and hence, we saw a rise in demand. However, for the housing market to reach out to the masses, the developers need to bridge the demand and supply mismatch and build a sustainable name and brand. Consolidation is the answer to this,” says Josy Mathew

About 20 years ago, one litre of milk would have cost about ₹15. However, today, it ranges from ₹55 to ₹60. This mechanism is known as inflation. It surges and dips with the fluctuations in demand and supply, production costs, and other factors, ranging from rising fuel prices to a global pandemic. But, it does not completely go away.

Last year, inflation roared the loudest in over a decade. Worldwide, the rate amounted to roughly 4.37% compared to the previous year, which was approximately 3.18%. The state is volatile, and the future is tentative.

But, amidst all this hubbub, the lingering question is, if we cannot eradicate inflation, how can we safeguard ourselves from its influence? This is where the role of investment in real estate comes into play.

How Does Real Estate Offer Hedge Against Inflation?

As inflation rises, net returns on stocks, bonds, and fixed-rate vehicles are likely to take a hit. On the other hand, real estate managers can reduce the impact of inflation by increasing rents of managed properties.

Obviously, this doesn’t happen uniformly across markets or property types. But can you remember having a landlord who seemed oblivious to rising inflation, leaving you with a jaw-dropping deal on rent? Indeed, it takes a piece of foresightedness to combat inflation efficiently.

Given below are some tactics that professional real estate managers implement to lessen the risk of soaring inflation:

CPI Indexation

Contractually tethered rent grows with the increase in the CPI (Consumer Price Index). While this may appear extremely complicated, it was fairly traditional back in the 70s and 80s when inflation was more prevalent.

Periodic Rent Reviews

These are created into leases. A periodic rent review is specifically essential with longer-term leases and/or when a few tenants occupy the property.

To Shift Operating and Capital Improvement Costs to Tenants

Sponsors or promoters may be able to transfer some of the improving and operating costs of properties to tenants. Specifically, utilities, services, and materials are likely to drive alongside inflation. While this transition may demand reducing gross property rents to stay competitive in leasing, it can significantly impact net operating income (NOI) over longer leases.

Note: This applies to non-residential CRE asset classes, including retail, office, and industries.

Limited Supply of Properties in Urban Areas

While land use and availability of properties are not much of an issue in suburban areas, it is a major factor affecting real estate property prices in the metropolis. This is mostly because there is a limited supply of properties in densely populated urban areas. Plus, the availability of land for building new structures is rare.

So, if you own properties in such urban areas, selling them during inflation could prove to be a win-win deal for you. How? The demand for real estate properties rarely decreases despite inflation. Resulting to which, there is a high possibility that property value will increase, given the increasing cost of labour and materials for building a comparable structure.

Who Benefits from Inflation?

Assuming that consumers will experience the most benefits of inflation would be unfair. While they do, it’s on a minimal level. On the contrary, investors enjoy the maximum advantages if they possess assets in markets affected by inflation.

For instance, if the economy is functioning well and housing demands are high, the real estate industry or the home-building company may charge higher prices for selling properties and homes.

Some corporations extract the rewards of inflation if they can charge more prices for their goods as an outcome of a spike in demand for their products. Another example could be the energy businesses. If you have invested in energy stocks, you might witness a rise in the companies’ stock prices when the prices increase.

In other terms, inflation can offer businesses pricing power and boost their profit margins. If the profit margin rises, it indicates that the rate of the companies’ products is growing at a faster pace than the growth in the costs of production.

Other Assets that Provides Protection Against Inflation

In the market economy, inflation is a natural phenomenon. Besides real estate, several other elements offer a hedge against inflation. A disciplined and experienced investor can mitigate the risk of inflation by investing in asset classes that transcend the market during inflationary conditions.

Adding inflation-hedged asset classes to your portfolio can help it thrive when the time arises. Below are some of the best ways to hedge against inflation besides real estate.

• Gold
• The S&P 500
• Commodities
• A 60/40 Stock/Bond Portfolio
• TIPS (Treasury inflation-protected securities)
• Real Estate Income
• The Bloomberg Aggregate Bond Index
• Leveraged Loans

Significant Factors Driving Inflation

A plethora of elements causes inflation or drive prices in an economy. Typically, inflation is the result of the following:

• An increase in production cost
• A rise in demand for products and services
• Devaluation, and
• Rising wages

• Production Cost: Cost-push inflation is caused by a hike in production costs such as wages and raw materials. The demand for goods remains constant while their supply reduces due to higher production costs. Eventually, the costs of production are borne by the consumers in the form of higher prices for the finished products.
• Increase in Demand: An inflation driven by the strong consumer demand for products and services is demand-pull inflation. When the demand for a wide array of goods across an economy surges, their prices increase.
• Devaluation: Devaluation is the aftermath of the soaring costs of imported goods and is one of the primary factors boosting domestic demand.
• Rising Wages: The higher the wages, the more will be the firms’ costs. Eventually, this increases the disposable income of the consumers to spend more.
• Real estate can be a reliable investment that can shield the investor from the ill effects of inflation. But, this stands true only when it is managed well. If you are a passive investor, you would definitely want to know if the sponsor or the promoter has planned for extending NOI at pace with inflation. This will ensure that the returns aren’t watered down over time.
• Amidst inflationary challenges, you can wish that the private real estate in your portfolio will cope better. However, if you don’t have private real estate in your portfolio, it may be the right time to consider rebalancing your portfolio toward the same if you are administering less than 15% of it.

Josy Mathew, MD and CEO,  LIvvehomes.com, advises, “A major shift that happened during the recession time was the emergency of the end user being the major investors for new projects. Traditionally developers and builders generate their initial cash flow through retail investors which saw a major downfall during recession. However at the same time, end user buyers increased by manifold to make good use of the price reductions and choice availability in the market. Real estate assets have always been a major investment decision for the end users. Seeing them emerge as the major cashflow machines for developers is a highly welcome change in the market and one that will only make the industry more stronger. 

Livvehomes.com is a next-generation real estate marketing and analytics platform working in all major metro cities in India and globally. Livvehomes.com is one of India’s largest real estate investment and marketing firm operating across the country that invests, partners and works with real estate developers, channel partners and property owners maximising profit yields for all its stakeholders.