Real estate investors should not fear a higher inflation environment, which may be more beneficial to them as it offers investment protection from supply issues while driving up the residual value of improvements, according to Quay Global Investors.
Justin Blaess, Quay Global Investors portfolio manager, said listed real estate was a good inflation hedge as it was tangible and provided intrinsic value as a shelter or place to do business.
“Because of supply constraints, well-located land will generally appreciate over time,” Blaess said.
“In addition, the cost of replacing any improvements built on the land will also increase through inflation.
“This is significant, because if there is excess demand for a type of real estate, the market will have to accept rising costs and thereby the rents required to economically justify construction – regardless of the inflation environment.”
However, Blaess said investors should understand how listed real estate had performed in previous periods where inflation had been elevated.
“Our analysis shows that listed real estate is an excellent hedge for inflation and has historically delivered strong positive nominal and real returns in higher inflationary environments. It also offers a better relative return when compared to general equities,” Blaess said.
“This is especially so when inflation is in the moderate 3% to 6% range, where listed real estate has historically generated more than double the real return relative to equities. Even with very high inflation (6% and above), listed real estate continues to outperform equities (albeit at a lower relative level than in a moderate inflation scenario).”
The Quay manager stressed that over the past 50 years, inflation was above 3% more often than below. When it was below 3%, listed real estate nominal and real returns were quite a bit lower than in a moderate inflation environment.
“Contrary to common belief, in lower inflation settings listed real estate returns actually tend to lag equities,” Blaess said.
“As someone with a vested interest in the performance and outlook for real estate, when it comes to inflation, we say ‘take a long view and don’t be fearful’.”