Our own investment analyst Amna Nawaz explains the impact inflation can have on commercial real estate (CRE) and how, historically, CRE investments have helped mitigate the effects of inflation on investor portfolios.

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Inflation: How Real Estate Can Act as a Hedge

Inflation is a universal economic phenomenon that affects individuals, businesses, and entire economies. When the general price level of goods and services rises, the purchasing power of money decreases, resulting in a decline in the standard of living for many. As a result, investors and individuals alike must seek hedges against inflation to protect their wealth. Real estate, which has historically proven to be a reliable hedge against inflation, offers investors a tangible asset that can outpace the rate of inflation, ensuring the preservation of purchasing power and wealth.

One of the key reasons real estate is an effective hedge against inflation is its ability to maintain and grow in value over time. Unlike financial assets, real estate is a tangible asset that possesses intrinsic value and can generate income through rental payments or capital appreciation. As inflation increases, the value of real estate tends to rise in tandem. For instance, if the general price level rises by 5%, the value of an individual’s real estate portfolio is also likely to rise by a similar percentage, thus offsetting the erosion of purchasing power caused by inflation.

Additionally, real estate investments can benefit from rental income that can be adjusted to keep up with inflation. As prices rise, landlords can increase their rental rates, ensuring that the income generated from their properties remains in line with inflation. This rent adjustment mechanism helps to maintain the purchasing power of the property’s cash flow, making real estate an attractive hedge against inflation.

Another advantage of real estate as an inflation hedge is the ability to leverage financing. In periods of inflation, borrowing costs are typically lower, as interest rates tend to rise. This presents an opportunity for investors to take advantage of low borrowing costs and secure long-term debt on real estate assets, further increasing their potential return on investment. By utilizing leverage, investors can amplify the potential benefits of an inflationary environment, which can contribute significantly to their overall wealth preservation.

Furthermore, real estate investments possess a unique feature called depreciation. Depreciation is an accounting tool that allows property owners to deduct the cost of the building structure over its useful life. This non-cash expense reduces taxable income and consequently lowers the tax liability associated with real estate investments. As inflation climbs and pushes property values higher, depreciation can help investors offset some of the taxes incurred, providing another layer of protection against the effects of inflation.

It is crucial to note that while real estate has historically acted as a reliable hedge against inflation, there is no guarantee that it will continue to do so in the future. Real estate markets can experience downturns, and factors such as location, market conditions, and regulatory environment can impact its performance. Therefore, it is essential for investors to conduct thorough research, assess their risk tolerance, and diversify their investments to mitigate potential risks associated with real estate investments.

In conclusion, inflation poses a threat to individuals and investors, eroding the value of money and decreasing purchasing power. However, real estate has proven to be a valuable hedge against inflation throughout history. With its potential for appreciation, rental income adjustments, leverage benefits, and depreciation advantages, real estate offers investors tangible assets that can outpace inflation. Being aware of the risks and conducting careful analysis, investors can effectively utilize real estate as a hedge to protect their wealth and preserve purchasing power in an inflationary environment.