Investors Buying Real Estate to Beat Inflation May Find Tactic Backfires

Many retail and office buildings currently have high vacancy rates, which can hamper raising rents. PHOTO: AMIR HAMJA/BLOOMBERG NEWS

By Konrad Putzier May 25, 2021 8:00 am ET

Investors are eyeing real estate as a way to hedge against inflation. Many are bound to be disappointed. While single-family homes usually perform well during inflationary periods, values of offices, retail buildings and other commercial properties can tumble in value if owners aren’t in a position to increase rents, economists say. Since the Labor Department this month reported a 4.2% annual increase in April consumer prices—the highest rate since 2008—the prospect of inflation has become an obsession in financial markets. Many analysts and investors expect the surge to be brief. They suggest that the inflation jump reflects recent government spending, pent-up demand and production bottlenecks during the reopening of the U.S. economy. These forces should subside, as the economy continues to recover from the pandemic, and more traditional spending patterns resume.

But with a number of U.S. companies warning of higher prices, more investors are seeking assets whose value goes up when the value of money goes down. Residential real estate has proved to be a haven during inflationary periods of the recent past. Stanford University economist Monika Piazzesi studied U.S. inflation of the 1970s and found that home prices rose relative to the size of the economy, while stock prices fell, meaning homeowners became richer compared with stock owners. If inflation were to stick around today, “exactly the same thing will play out,” Ms. Piazzesi said. Owners of residential and commercial real estate are often better off during times of rapid inflation than owners of stocks or bonds, economists say. Office, retail and apartment rents are typically tied to consumer prices and rise with inflation, pushing up property income. Inflation also makes construction more expensive, which benefits property owners because they can expect less competition from new buildings. There is also the crowd psychology: Real estate has a reputation as an inflation-proof investment, and more people buy it simply because they think others will, too. But landlords who are unable to raise rents can suffer during periods of inflation. Single-family homes usually perform well during inflationary periods. PHOTO: BING GUAN/BLOOMBERG NEWS Office and retail leases often last for 10 years or more, and unless they include inflation-related rent increases, landlords see their real income shrink. Rising inflation also typically leads to rising interest rates, which pushes up the yield for risk-free bonds and weighs on property values by making their yields look skimpier in comparison. If landlords can’t raise rents enough to compensate for that, inflation makes them poorer. Many retail and office buildings currently have high vacancy rates, which can also hamper raising rents. Inflation only leads to higher prices for products that people actually want. David Hartzell, a professor of real estate and finance at the University of North Carolina, studied the impact of inflation on U.S. real-estate returns in the 1980s. He found that the property sector didn’t work well as a hedge when vacancies were high. “If there’s a lot of vacancy, at the margins landlords lose their bargaining power,” he said. The FTSE Nareit Equity REITs index, which tracks public real-estate investment trusts, fell slightly on May 12, the day the Labor Department published its consumer-price report. Although the index has since more than recovered the loss, it indicates that investors have mixed feelings about the impact of rising consumer prices on real estate. John Vojticek, head of liquid real assets at asset manager DWS, said he expects inflation to come down again but remain slightly higher than before the pandemic. HEARD ON THE STREET

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He said his firm is pessimistic about office owners, whose long-term leases make them vulnerable to inflation in the near term. For now DWS is more keen on owners of rental homes and storage units, where leases are far shorter and raising rents with inflation is easier. “Real estate is basically a bond with equity upside,” he said. “I’d rather be on a two-year bond than a 10-year bond if rates are rising.”