Safe As Houses? The Inflation-Busting Benefits Of Investing In Property

Schroders

Contributor:
Schroders
Visit: Schroders

By:

Co-Head of Global Real Estate Securities

Real estate assets can generate significant returns for investors, with cash flows keeping up with (and in some cases exceeding) inflation levels.

Although residential property can be a sound investment, it is also one of life’s essentials. Everyone needs somewhere to live. It is this basic human necessity that is the reason why housing is included (along with transportation and food) as one of the three largest components of the US consumer price index (CPI).

The chart below shows how dramatically the cost of housing in the US (labelled “shelter” by the CPI) has increased since the start of 2021. Owners of residential assets can generate a real return as their cash flows keep up with, and in some cases, exceed inflation levels.

The chart shows how dramatically the cost of housing in the US (labelled “shelter” by the CPI) has increased since the start of 2021.

And it’s not just the residential sector that can provide protection against inflation. Many leases across all types of sub-sectors have explicit commitments to rental increases (or “escalators) tied to inflation. In some instances, there are also leases with fixed escalators or rent reviews at specific times.

These all give investors the opportunity to ensure their income generates a real return; that is, one that is above inflation.

Historical protection against inflation

The essential nature of many property assets, such as residential (everyone needs a place to live), healthcare (everyone gets sick at some point), or data centres (everyone communicates digitally) is one of the reasons why investors have historically been protected from inflation.

This is backed up by a study carried out by the Bank of America (see chart below) into the correlation of various asset classes with US CPI between 1950 and 2020. It concluded that real assets are a hedge against inflation. 

Choose your property assets carefully

The Covid-19 pandemic has accelerated a number of trends, such as e-commerce and working from home. These long term, structural issues have weakened the pricing power for owners of property assets such as retail and office space. Consequently, the ability to pass on inflationary increases to tenants in these buildings is severely limited.

Low levels of demand and high amounts of supply are a toxic combination for any market. We believe that certain sub-sectors will continue to experience challenging operating environments over the medium to long term. Therefore, it has never been more important to select the right type of real estate to own.

How can investors achieve pricing power today?

Focusing on locations where economic growth is consistently the strongest means that investors can maximise their chances of being able to pass on increased costs to their tenants.

There are certain sub-sectors which are characterised by very low levels of supply. For example, obtaining planning permission to build data centres, warehouses, self storage units or student accommodation in many cities can be incredibly difficult. Yet the demand for these types of assets continues to grow.

The pricing power in certain sub-sectors is set to increase as the cost of raw materials reduces the amount of construction starts.

There are two key reasons for the lack of new property entering the market.

Firstly, the pandemic led to an initial slowing in new supply as construction sites were shut down. Secondly, dramatic increases in the cost of raw materials and supply bottlenecks have resulted in lower margins for developers. While this is frustrating for developers, the silver lining is that it increases both the value and demand for existing assets.

Many investors worry about the impact rising interest rates will have on the real estate sector. However, history demonstrates that this should not be a cause for concern. At the start of the last two rate hiking cycles the global real estate investment trust (REIT) sector has finished with positive total returns.

Originally Posted May 16, 2022 – Safe as houses? The inflation-busting benefits of investing in property

The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.

Disclosure: Schroders

Important Information: This communication is marketing material. The views and opinions contained herein are those of the author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. It is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a reliable indicator of future results. The value of an investment can go down as well as up and is not guaranteed. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Some information quoted was obtained from external sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. This does not exclude any duty or liability that Schroders has to its customers under any regulatory system. Regions/ sectors shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The opinions in this material include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realized. These views and opinions may change.  Schroder Investment Management North America Inc. is a SEC registered adviser and indirect wholly owned subsidiary of Schroders plc providing asset management products and services to clients in the US and Canada.  Interactive Brokers and Schroders are not affiliated entities.  Further information about Schroders can be found at www.schroders.com/us. Schroder Investment Management North America Inc. 7 Bryant Park, New York, NY, 10018-3706, (212) 641-3800.

Disclosure: Interactive Brokers

Information posted on IBKR Traders’ Insight that is provided by third-parties and not by Interactive Brokers does NOT constitute a recommendation by Interactive Brokers that you should contract for the services of that third party. Third-party participants who contribute to IBKR Traders’ Insight are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.

This material is from Schroders and is being posted with permission from Schroders. The views expressed in this material are solely those of the author and/or Schroders and IBKR is not endorsing or recommending any investment or trading discussed in the material. This material is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

In accordance with EU regulation: The statements in this document shall not be considered as an objective or independent explanation of the matters. Please note that this document (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research, and (b) is not subject to any prohibition on dealing ahead of the dissemination or publication of investment research.

Any trading symbols displayed are for illustrative purposes only and are not intended to portray recommendations.