Commercial real estate in the United States should remain a strong investment choice as the nation emerges from a pandemic-induced slump, and it can be a good hedge for investors worried that rising inflation could dampen or even derail the recovery.
That’s the argument of analysts at CoStar Advisory Services, who summarized their thesis in a new white paper called “Why U.S. Commercial Real Estate?”
Monthly rents and other real estate income tend to help real estate keep up with rising inflation, the report said. And since 2000, such cash flows have helped real estate outperform stock and bonds, which can be subject to the daily whims of the stock market or tied to rising or falling interest rates.
Investors are likely to find real estate attractive at a time when bonds are offering near-record-low yields, the paper argues. Moreover, one of the benefits of privately owned commercial real estate is that it can generate returns during periods of economic volatility, said Nancy Muscatello, a managing consultant with CoStar Advisory Services
Muscatello, who authored the report with senior consultants Juan Arias and Joseph Biasi, said rising rents and occupancy rates help boost real estate returns when times are good. When the economy stumbles, steady rent income can provide a buffer.
The economy has been improving of late. Growth has returned to levels recorded before the pandemic, job openings have risen sharply and rising consumer confidence has helped fuel a release of pent-up demand during the spring and summer, all factors that should help the prospects for real estate, according to the paper.
Still, there are reasons for caution.
The recent surge in new cases of COVID-19 due to fast-spreading variants of the virus, especially in areas with lower vaccination rates, could slow or reverse progress made in the first half of 2021 as states reopened their economies. And there are other headwinds: Lower-wage businesses such as restaurants are having difficulty filling positions, and increased inflation has caused some to worry about the strength of the recovery once consumers spend their fiscal stimulus checks.
Policymakers are currently debating how hot the economy might run; Federal Reserve Chairman Jerome Powell has said a recent surge in rates should be “transitory,” or temporary. But as inflation increases, interest rates are being held at historically low levels by the world’s central banks and governments, reducing yields on bonds and other traditional investments. Low bond yields tend to cause investors to shift to assets with higher returns such as stocks and real estate.
Real estate should prove attractive because returns tend to rise over the long term as a result of increasing rental rates, whereas interest income from many bond investments remains fixed or erodes in value because of inflation. Investors can further reduce their risks by considering a diverse portfolio of assets as well as a mix of property types including industrial, office, multifamily and retail.
“We don’t expect inflation to be 5% forever, but we do expect it to be higher than it was, which is why its important to make the argument that commercial real estate is a good inflation hedge and an important part of a well-balanced portfolio for any investor,” Biasi said.
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