Should CRE Prepare for Always High Inflation?

According to a Bloomberg story, if you believe that rising inflation is only a transitory issue and that everything will return to normal before the pandemic, you disagree with some of the largest bond investors in the world. They believe that the Federal Reserve’s target of 2% inflation is essentially an impossible dream, which is why they have piled up on inflation-protected bonds, increased their exposure to commodities, and maintained a sizable cash reserve.

Cheap energy and labor kept inflation low over a protracted period of growing globalization. (A sober addition would likely be the long-term cheap monetary supply that central banks kept thinking would boost GDP.)
But it’s time to take a deep breath. Look up the U.S. yearly inflation rate for the past few years. The Fed’s goal inflation rate of 2% was greatly exceeded for numerous stretches. The commercial real estate market did not collapse.Looking at the recent past is something that might confuse people. According to Kevin Swill, CEO of Thirty Capital Financial, “to have a market, with low interest rates for more than 12 years, does not follow logic or the cycle that existed for decades.”

However, returning to normal does not guarantee that it will be painless, especially in light of the investment methods that were used in conjunction with those low rates. “Levered investors might struggle to cover debt service and secure loans if cap rates spreads to interest rates narrow,” said DWS Group’s U.S. Real Estate Strategic Outlook for July. “Real estate leasing could also retrench amid job losses and dwindling profits. Indeed, recessions have been the proximate cause of every broad-based decline in real estate prices since the early 1960s.”

Additionally, as the Fed attempts to restrain growth, increasing inflation will result in continuous higher interest rates. That will have an impact on the price of finance as a whole.

Peter Tuffo, president of the south region for Suffolk Construction, claims that the real-estate industry runs on credit and the fundamentals of real estate are out of balance. Real estate investment is tied to confidence, and some projects are simply not penciling out. Real estate responds negatively to higher risk.”
Rogelio Carrasquillo, managing shareholder and cofounder at Carrasquillo Law Group, tells GlobeSt.com that “this situation has a significant effect on bridge and short-term loans that become more expensive for developers. As a result, programs such as EB-5 and other alternative sources of financing that would not be considered otherwise, become viable alternatives for the financing and development of commercial real estate projects.”

Even said, not all is lost because, according to Zachary Streit, founder and managing partner at WAY Capital, “inflation could also mean higher rent growth and NOI that could offset some of the impact of higher interest rates.” Additionally, “We are seeing a trend of more deals getting done with fixed rate financings and some sort of partial recourse or creative financing structures like PACE to offset today’s higher rates offered by floating rate lenders.”