ISSUE 2 | 2022
INFLATION HEDGE Investors through all asset classes are thus looking for a hedge on inflation. From a property value standpoint, there has been an historical inverse relationship between prices and interest rates, which is mostly due to purchasing power capacity. When money is drying up, the pool of buyers is reduced, resulting in a lack of demand. In appraisals, this typically would be reflected in an increase in capitalization rates and discount rates. On the other hand, as long as grown revenue remains affordable by demand, a high inflation rate would not necessarily erode property valuation, as cash-flow generating properties would exhibit superior cash-flow growth, compared to historically low-inflation periods. In addition, fast growing cash-flows are beneficial for homeowners, given that debt outstanding remains flat. Consequently, in the long run, higher-than-average inflation may result in better unlevered and levered returns for an overall similar level of risks.
ATTRACTIVE ASSET CLASS Counterintuitively, such an environment may actually benefit real estate values. Investors may therefore start using Real Estate as a hedge against inflation by capitalizing on still cheap mortgage interest rates, passing through rising costs to tenants with higher rent prices, and benefiting from rising home values over the long term. Such a trend would further drive up the values of Real Estate and maintain its position as one of the most attractive asset classes available. This trend is likely to continue, especially for residential properties but also for multi- functional assets in the Industrial and Logistics sector. While inflation will likely have an impact on all asset classes of Real Estate, asset classes are expected to bear differently. With supply chain disruption continuing, BDO’s Real Estate and Construction group expects industrial and logistics properties to further consolidate their advantage. On the other side of the spectrum, the retail and hospitality sector may weaken further and will be extremely dependent on the shift in consumers’ habits i.e. where and how consumers shop and where consumers go. Office properties appear to be at risk in core Central Business District (CBD) markets.
An inherent risk to the Real Estate sector caused by inflation relates to the increased cost of building materials, which will slow down construction in various areas. Therefore, property owners with good assets might even see an added benefit from reduced new supplies coming to the market, which will allow for an increase in rental rates. While historically it was to be expected that increases in global interest rates, as a result of the effort to curb global inflation, may trigger an overall decrease in property values, there are factors which may yet send the real estate market into overtime. Current owners may be able to benefit from the inflationary environment with higher cash-flows in prospect. Real Estate operators, investors and managers will need to closely monitor this broad dynamic in the coming months and property values may not necessarily be found to be negatively impacted. The BDO Real Estate and Construction group has set up a global Real Estate Valuation network to address the valuation challenges associated with these complex problems, allowing it to work on several different markets and maintain an overall market view of Real Estate.
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