June 8, 2022
High and rising inflation systematically poses a threat to the performance of traditional investment classes. With the Fed working furiously to respond to inflation and restore price stability through drastic interest rate hikes, many investors are concerned about the short- and long-term prospects for alternative investments as well.
Naturally, no investment is without risk. That said, for investors seeking a portfolio hedge as the economy moves into a period of unsettled interest rates, the resilient profile of strategic real estate investments can still offer strong returns.
As a vertically integrated real estate sponsor that has successfully navigated many real estate cycles and market fluctuations, we have identified the key fundamentals that make real estate investments, specifically multifamily, the most resilient in today’s macroeconomic climate.
Below we discuss these fundamentals and provide insight on how investors can combat inflation and rising interest rates to maximize returns:
1. Real estate investments continue to thrive despite relentlessly strong inflation. But not all property types fare the same.
When considering traditional investment assets such as bonds and stocks, inflation historically erodes principal value and pushes down the price investors are willing to pay. While in response, rising interest rates weigh on asset prices—sometimes reversing the wealth effect for investors.
Since the coupon on most bonds or fixed-income securities remains the same until maturity, the purchasing power of the interest payments declines as inflation rises.
For equity investors, market participants frequently discount future cash flows at a higher rate when inflation rises. The higher the level of inflation, the greater the discount rate applied to earnings, thus lowering the value the stock.
Despite peaked inflation and rising interest rates, over the past year, real estate investments have continued to produce steady, predictable income. That said, certain real estate property types are more vulnerable to inflation and climbing interest rates than others—with multifamily assets in particular standing apart. Characterized by short-duration leases, or by rents linked to revenues, multifamily assets provide the highest level of inflation protection.
Due to their ability to maintain dynamic cash flows, multifamily real estate assets are well-positioned for resilience. Leases for multifamily properties embody shorter terms of just one year, often followed by monthly lease extensions. This fundamental allows asset owners to quickly adjust rents to compensate for inflation and capitalize on increased demand.
2. An increase in Treasury rates does not always produce an equal increase in borrowing costs—they do not move in lockstep.
It is important to note the nuanced relationship between Treasury rates and borrowing costs. Margins, or loan spreads, charged by lenders can actually be reduced during periods of rising rates. Such narrowing of loan spreads is often seen in competitive lending markets—like multifamily, where agency lenders are active.
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