Is Commercial Real Estate Inflation-Proof?
by Trey Finch
Real estate has an almost uncanny ability to maintain (or even increase) its value, regardless of what is happening in conventional markets at any given time. Investing in commercial real estate (CRE), in particular, could offer an especially desirable strategy for the next several months.
The sentence above is not a guarantee—but it’s easy to feel conviction towards CRE in today’s market. Cities like Nashville, Austin, Charlotte, and the like offer intriguing opportunities to diversify your investment portfolio. and potentially shield some of your wealth from market volatility.
Learn more about commercial real estate, including:
What is CRE?
How does commercial real estate’s value fare during inflation?
Are there any disadvantages to CRE investing?
What are the advantages of commercial real estate?
Why is CRE investing wiser than hoarding cash during volatility?
How can CRE help safeguard your portfolio’s equity?
What Is Commercial Real Estate?
We should start with the basics: Commercial real estate (CRE) is property used solely for either business or a workplace, specifically. In either case, it is not usually used as a living space (except in the case of apartment buildings).
More commonly, these include office buildings, shopping centers, medical centers, parking decks, and industrial warehousing, just to name a few. For clarity and convenience, they are often classified into one of four categories: office space, retail, multi-family rental, or industrial.
Lease rates are usually quoted in terms of dollars per square foot (comprising a rental property). Unlike residential real estate leases, which sometimes involve monthly rent, CRE leases tend to be assessed annually. Adding an element of stability is the fact that some commercial leases can run a decade or longer.
The Advantages of CRE
One of the biggest advantages of commercial real estate is its value. Sometimes described as immune to inflation, it is probably more accurately described as beyond inflation’s typical reach. It does tend to hold steady, but real estate is not magically immune to losing value.
Another advantage is the diversification it brings to an investors investment portfolio. is the fact that CRE is not assessed using the stock market as a metric. So while volatility and interest rates may adversely affect your traditional investment holdings (stocks and bonds) - CRE. does not track up or down due to bull or bear markets. In fact, the economic source of real estate’s value is completely different.
Much like residential real estate, CRE’s worth is derived exclusively from local property values. In other words, if an area is in high demand (e.g. the retail heart of a densely-populated area), leases and price tags will be high. Meanwhile, CRE properties that are further away from a city’s arteries are typically valued lower.
Again, generally speaking, commercial real estate tends to hold its worth over the long term. Each year tends to bring a new manufacturer seeking a production floor, an established retailer looking to expand, and so on. If, however, a volcano suddenly emerges in the parking lot, spewing poisonous gas, local property values will plummet.
Otherwise, even with inflation raging all around, real estate’s worth does not change. This is probably its most prized trait, but the steady income does not hurt, either: Since most commercial leases are at least a year long, rental income from tenants is a near certainty.
Some CRE leases even have built-in clauses specifying a 1-3% annual increase in rent for inflation. That can cause local property values to rise, as a side effect. So, over time, inflation can potentially increase both your equity and your returns from commercial real estate investing.
We Have Tips for Safeguarding Your Nest Egg by Adding Alternative Investments to Your Portfolio Here.
In fairness, commercial real estate doesn’t represent the perfect investment for every investor. There are possible downsides to CRE that may not make it the right choice for you! This type of investment can require a lengthy time commitment and potentially large capital commitments.
As noted above, a 10-year lease can bring about stability – but if something were to change your cash flow, it’s easy to imagine a situation where you might feel stuck with CRE. Additionally, the initial investment is typically larger than what you’d pay for a residential property. Where an Airbnb typically only involves renting out someone’s home, commercial renters’ needs often require larger-scale buildings. The extra expense is seldom a problem for High Net Worth (HNW) investors and Ultra High Net Worth (UHNW) investors, but it can lead those with shallow pockets to pool their funds – which can add another element of friction.
Commercial real estate can also get somewhat riskier, depending upon the type of property you invest in: There is probably a fender bender in a commercial parking lot somewhere within the continental U.S. every day. These areas see high volumes of people, which raises the likelihood of occasional mishaps – so it’s important to understand the risk involved in the type of property and be sure you are buttoned up on the insurance in place
Could CRE Investing Hedge Your Equity?
When the market goes through uncertain phases and inflation shrinks money’s purchasing power, knee-jerk reactions can prove costly. For instance, one of the biggest mistakes investors make is cashing out their investments when markets are volatile and sitting on large sums of cash
One of the problems with this is that—when inflation means our currency is losing value in the first place—you can worsen your financial situation this way. Invested money; your equity generally holds steady (even if overall market values dip) while withdrawn cash may keep declining.
Like perishable food in late summer, hoarded money shrivels in inflation, buying less and less. Meanwhile, leaving your equity in the investment freezer usually preserves its monetary worth: Financial assets retain value, even when cash’s purchasing power recedes outside the stock market.
Of course, we hope the dollar surges again soon. Nevertheless, we believe commercial real estate can be a protective hedge safeguarding your portfolio. Especially during inflationary periods and bull markets, the guaranteed income from rental agreements can help provide peace of mind, as well.
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