Investors’ concerns have shifted away from the immediate impact of lockdown restrictions to surging inflation driven by a mix of supply chain shocks and loose monetary policy. Once deemed transitory, it seems higher inflation is here to stay in the near to medium term.
Historically, real estate has long been seen as a good inflation hedge. Real estate’s attractiveness as an inflation hedge is primarily threefold:
- Capital and rental values typically increase in an inflationary environment
- Inflation reduces the real value of debt, which is commonly used in real estate transactions
- Performance of real estate, in particular residential, has a low correlation with stocks and bonds
Inflation means the purchasing power of cash falls, so it helps to have assets generating consistent income and capital growth, like property. This means we are likely to see increased allocations to real estate from institutional investors such as pension funds and insurers.
However, even within real estate, the impact of inflation will be uneven. This is because not all types of inflation – and not all property sectors – are the same.
In many ways, this current period of inflation is straight out of an economics textbook: aggregate demand is far outstripping aggregate supply.
Your Econ 101 textbook might suggest a positive scenario where economic growth and rising wages are driving demand for goods and services – ‘demand pull’ inflation. What we are seeing in the UK – and globally – is quite different: ‘cost-push’ inflation. In short, supply chains are still struggling from pandemic-related restrictions. Loose monetary policy from central banks has only added fuel to the fire.
The supply chain disruption we are seeing spells bad news for developers, who now have to manage spiralling construction costs. According to government data, in 2021 the price of construction materials such steel, timber and concrete rose by 23 percent. It is not unreasonable to expect without significant government intervention that house-building rates will slow down.
Yet this does not mean bad news for all residential property. Indeed, the single-family rental (SFR) sector in particular, which IMMO is helping institutional investors unlock, is uniquely well positioned to weather the inflationary storm we find ourselves in. Our technology removes the value chain inefficiencies which have historically prevented European institutions from aggregating long term, stable SFR investment portfolios.
The advantages of investing into SFR in today’s cost-push inflationary environment are clear.
Firstly, since inflation makes home ownership less affordable, demand for rental housing grows, and therefore rental income grows.
Secondly, provided you have fixed finance costs, the cost of debt should remain constant while the real value of debt is reduced.
Thirdly, since building new homes continues to get more expensive, supply of new housing falls. However, potential home buyers are feeling the pinch of affordability constraints. This means that home builders can’t simply pass the cost increases into their end pricing. Instead, they will likely reduce their supply of new housing. This means a small increase in demand has a multiplied effect on house price growth.
Finally, there is the short-term nature of residential leases versus commercial leases, which means SFR investors are better positioned to capture rental growth over owners of office blocks and shopping centres. Residential tenancies are typically renewed annually, giving landlords the ability to raise rents year-on-year. In contrast, commercial leases typically have a five-year rent review.
However, socially sensitive management is essential. Ramping up rents while households’ cost of living is rising will win the sector no friends and do it no favours. Investors have an opportunity not just to mitigate the risks created by an inflationary environment, but to align their strategy with the ‘S’ in ESG agenda through the right approach to rental pricing and management.