Is Commercial Real Estate a Good Investment
Despite the Risk of Inflation?
Successful real estate investors have long understood the importance of incorporating commercial real estate in their investment portfolios. While residential real estate investments provide a solid source of passive income, there are many variables that must be taken into consideration. For instance, if you invest in residential properties by fixing and flipping properties, it’s crucial that you’re investing in an area where homes are selling for a good price. Even if you’re renting out a single-family residence, there are variables to consider, including the going price of single-family rentals in your area. Those considerations must be made in addition to other factors, such as inflation.
Obviously, there are factors that must be considered when determining the viability of a commercial real estate investment. The business patterns of the community where you’re considering investing is crucial if you are investing in a business location. Additionally, inflation will have to be taken into account. However, many investors find themselves wondering if commercial real estate is a good investment despite the risk of inflation.
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What is Inflation?
Inflation is defined as a decrease in purchasing power of a given currency over the course of time. In most cases, when a currency’s purchasing power decreases, the price of goods and services increases. Inflation can be broken down into three different types: Cost-Push inflation, Built-In inflation, and Demand-Pull inflation.
Demand-Pull inflation is caused when an oversupply of money and credit stimulates the demand for goods and services. Cost-Push inflation is caused by an increase in the price of production of those goods and services. Finally, Built-In inflation is more about consumer expectations. In Built-In inflation, consumers assume that the cost of goods and services will continue to rise, leading to an even larger increase in prices.
At its root, inflation is caused by an overabundance of money or credit, however that principle can play out in a variety of ways in a constantly changing economy. Policymakers can have more money printed and circulated into the economy, they can lower interest rates in order to encourage borrowing, or they can pass laws that lower the value of legal currency. In all of these cases, money loses its purchasing power.
How Does Inflation Impact Real Estate?
Even though an increase in inflation typically leads to an increase in interest rates, there are also positives to inflation for real estate investors. First of all, generally produces higher prices for existing assets. In most cases, when inflation goes up, so does the cost of goods and services, including real estate. Additionally, inflation helps decrease the amount of existing debt, which is a great tool if you have an existing commercial real estate investment that you have leveraged funds for.
For instance, let’s assume that you purchased a $125,000 property five years ago, using a $25,000 down payment to secure the loan. In this hypothetical, you obtained a 25-year, $100,000 mortgage that includes a 3$ fixed interest rate. If inflation also increases 3% every year, you’re still only paying $475 per month, but the value of your money would continue to increase. That means that the relative cost of your debt decreases every time inflation hits.
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How Inflation Impacts Investing
When the value of money decreases, it’s sure to have an impact on different types of investments. For instance, publicly traded stocks (shares in companies on the New York Stock Exchange) generally decrease in value. This is because the average consumer has less purchasing power during periods of high inflation than during time of lower inflation. When consumers don’t have as much spending power, the amount of money flowing into these companies represented on the NYSE decrease in value.
However, many industry experts recommend that investors shift their focus to hard assets during time of higher inflation. Stocks and bonds, due to their intangible nature, are generally classified as soft assets. Conversely, hard assets are those investment assets that are physically present and can be used in order to generate income.
How Does Inflation Impact Commercial Real Estate?
Commercial real estate is a hard asset. That is to say that they are long-term assets that are used by companies to produce goods and services. In order to be considered a fixed asset, an asset must have an expected lifespan of more than one year. Hard assets, as they pertain to commercial real estate, generally include office spaces, retail spaces, factories, plants and other buildings that are used for business purposes.
With that information in mind, industry experts generally encourage investors to hold on to existing commercial real estate investments while also looking for opportunities to add additional commercial real estate spaces to their portfolios during periods of increased inflation. Unlike many other asset types such as precious metals, stocks, bonds, and even fix-and-flip residential properties, commercial real estate investments have the potential to continually generate income without being sold. To make commercial real estate even more attractive, potential tenants are willing to pay higher rent for a good commercial real estate space during periods of high inflation.
Over the course of the last two years (approximately), the United States economy has undergone a period of unprecedented turbulence due to the ongoing COVID-19 pandemic. The impact that the pandemic has had on different components of the nation’s economy are still up in the air. However, even in the midst of these uncharted waters, commercial real estate has continued to be a viable investment opportunity.
Inflation, just like every other economic factor, does have an impact on commercial real estate investments. However, due to its classification as a hard asset, commercial real estate, also referred to as CRE, is generally considered more valuable. If you are concerned about the impact of inflation on your investment portfolio, sit down with a list of your investments and determine which ones are hard and which ones are soft. If there’s room for additional commercial real estate investments, you can help protect your portfolio against inflation by adding them to your existing investments.
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