Inflation is a topic we’re hearing about a lot these days. It’s affecting consumers’ day-to-day lives as the prices of everyday commodities and more increase. Factors such as the global pandemic, shipping crisis, and labor shortages have influenced inflation more rapidly; but over the years, the average cost of goods have steadily increased.
The commercial industry is no exception. CRE, however, is considered a stable asset and is not impacted as much as everyday goods tend to be. The word “inflation” may have a negative connotation associated with it, but that’s not necessarily the case when it comes to CRE assets. Since rising inflation prices seem to be here to stay, let’s uncover how inflation impacts your CRE assets.
What is Inflation?
Simply put, inflation is the rise in the cost of goods and services in an economy over time. Prices go up and your purchasing power goes down. A factor of inflation is the supply and demand market. When supplies are in surplus, inflation is low. On the flip side, when supplies are scarce, inflation rises.
An example of inflation prices moving up steadily over time is movie tickets. In 1980, movie tickets cost $2.89 whereas the average price of a movie ticket in 2019 was $9.16. Less than forty years ago, $10 could buy you three movie tickets whereas, in 2022, $10 likely cannot buy you a single one.
Inflation levels depend on current events; wage increases and supply and demand influence rates. As previously mentioned, events such as the shipping crisis, shortage of workers, and a global pandemic have also impacted inflation rates in the United States.
When describing inflation, Forbes suggests not to “think of inflation in terms of higher prices for just one item or service… Inflation refers to the broad increase in prices across a sector or an industry, like the automotive or energy business–and ultimately a country’s entire economy.”
Inflation isn’t necessarily a bad thing. It is considered to be healthy in small increments, according to economists. Inflation rates, after all, do help when investing. Investing makes your money more valuable over time compared to simply keeping it in a shoebox in your closet.
What Does Inflation Do to Your CRE Asset?
Again, inflation isn’t necessarily a negative thing for CRE assets. CRE actually has a strong, positive relationship with inflation according to U.S. Bank. This stable asset benefits investors who are seeking investment opportunities that stand against the unpredictable nature of inflation.
Here’s what inflation might look like for your particular CRE asset.
Lease Agreements
It’s customary for rent prices in lease agreements to rise gradually by about two to three percent each year. If the increase in rent prices are higher than the inflation rate, there will be positive returns.
If inflation rates stay lower than the annual rent increase, CRE investors still see positive gains. If rent prices rise, but the expenses to operate a building stay about the same, this results in positive property values.
Forbes Advisor explains that positive property values can increase net operating income, adding even further property value. “As long as this value is more than the inflation rate, the investor’s investment will not be hampered if they are holding CRE.”
CRE Shortage
There is only so much land we can build on until we run out. In the wise words of American author Mark Twain, “buy land, they’re not making it anymore.”
His words ring true today more than ever. People all across the globe are buying land to build homes, apartments, and commercial buildings. Companies keep growing, which means they need more commercial space to work out of. The bottom line, however, is that we’re running out of space..
There is a high demand for space and supply is limited, especially in popular cities such as San Diego, New York, and Austin. This creates a market that makes space more valuable since it’s harder to come by.
This bodes well for CRE investors because high demand with limited availability pushes CRE value even higher. As long as the value can outpace inflation rates, there should be a continuation of positive returns for investors.
Is Now the Time to Invest in CRE?
Now that you know commercial real estate is positively impacted by inflation rates, you might be thinking it’s the time to invest in commercial property. A few factors to consider before:
- Economic recovery
- Down payments
- Financeability
- Income opportunity
- Prepayment penalties
Learn more about if now is the time to invest in commercial real estate properties on the blog.