How Inflation and Rising Interest Rates Affect Real Estate Investments
High and rising inflation systematically threatens the performance of traditional investment classes. As the Fed works hard to address inflation and restore price stability through drastic interest rate hikes, many investors are also worried about the short- and long-term outlook for investments. alternatives.
Of course, no investment is without risk. That said, for investors looking for portfolio hedging as the economy enters a period of volatile 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, especially multifamily, the most resilient in the current macroeconomic climate.
Below, we discuss these fundamentals and provide insight into how investors can fight inflation and rising interest rates to maximize returns:
1. Real estate investments continue to thrive despite still high inflation. But not all types of properties are created equal.
When considering traditional investment assets such as bonds and stocks, inflation historically erodes principal value and drives down the price investors are willing to pay. In response, rising interest rates weigh on asset prices, sometimes reversing the wealth effect for investors.
Since the coupon of most bonds or fixed income securities remains the same until maturity, the purchasing power of interest payments decreases 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 higher the discount rate applied to earnings, which lowers the value of the stock.
Despite the spike in inflation and rising interest rates, over the past year, real estate investments have continued to produce stable and predictable income. That said, some types of real estate are more vulnerable to inflation and rising interest rates than others, with multi-family assets in particular standing out. Characterized by short-term leases, or income-related rents, multi-family assets offer the highest level of inflation protection.
Due to their ability to maintain buoyant cash flows, multi-family real estate assets are well positioned to weather the storm. Leases for multi-family properties include shorter terms of just one year, often followed by monthly lease extensions. This fundamental allows asset owners to quickly adjust rents to offset 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 parallel.
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 lending spreads is often seen in competitive lending markets, such as multifamily, where agency lenders are active.