For the past year, consumers have felt the financial pain of rapidly rising prices across a wide range of products. Whether you’re shopping for groceries, purchasing a big-ticket item, or simply filling your gas tank, it’s hard to ignore just how impactful our high inflation environment is on your purchasing power.

In February of 2022, the annual inflation rate in the United States accelerated to 7.9% - the highest since January of 1982.¹ The Consumer Price Index (CPI) also had the highest increase in 40 years.¹ While the Federal Reserve originally forecasted inflation to ease towards the end of 2022, it now appears our high and persistent inflation will be with us for some time, as U.S. Treasury Secretary explained in a recent interview.

“We’re likely to see another year in which 12-month inflation numbers remain very uncomfortably high.”

- Janet Yellen, cnbc.com, March 10, 2022

If you’re a real estate investor, you may wonder how this rising price environment will impact your current holdings and whether you should make some adjustments to your portfolio. Here are a few things to consider before you make your next move:

How Inflation Affects Real Estate

Extended inflationary periods affect the real estate market in a variety of ways; Some of the most significant include the influence on property values, rents, and financing.

Property Valuations

Labor and construction material costs tend to rise during inflationary episodes, which can slow the development of new projects. This often creates a supply shortage for many different real estate assets, fueling demand and increasing property values. So, commercial real estate investors could benefit from property appreciation during rising inflation.

Rent Rates

Many commercial property contracts contain escalation clauses, enabling owners to raise rents as their labor and property management costs increase. Annual increases are often tied to increases in the CPI. And multifamily property leases, written for shorter terms (6-12 months), allow owners to raise rents quickly, which may be at rates higher than inflation.

Financing

Inflation can impact commercial real estate investors in either a positive or negative way. For example, property owners who secured long-term fixed financing in the last few years when rates were at all-time lows will most likely avoid the need to refinance as rates increase. Conversely, owners who need financing during rising inflation will pay higher rates, which typically raises their operating costs.

A Time to Buy?

While real estate still has it owns risks, you may be happy to know real estate is an inflation hedging strategy. Real estate owners likely have seen property value increase over the last year and may be wondering if this would be a good time to sell.

Many other investment property owners may be weighing that same decision. One compelling strategy for potential sellers to maximize gains today, yet not get clobbered with capital gains tax, is to consider a 1031 exchange.

The 1031 exchange is a provision in the Tax Code, allowing investment property owners to defer capital gains and depreciation recapture taxes when exchanging an existing property for a “like-kind” replacement property. 

We believe tax deferral should be increasingly important during high inflationary times, when appreciated property values may be at their highest.

We hope you have found this introduction on inflation and commercial real estate helpful. In Part II, we discuss several investment concepts in further detail, including a deeper dive into four strategies that may help an individual properly allocate real estate investments during this period of inflation.

Fore more info, contact our team to schedule a consultation.

¹ https://tradingeconomics.com/united-states/inflation-cpi#

Because investor situations and objectives vary this information is not intended to indicate suitability for any individual investor.  

This is for informational purposes only, does not constitute as individual investment advice, and should not be relied upon as tax or legal advice. Please consult the appropriate professional regarding your individual circumstance. Fortitude Investment Group does not offer legal or tax advice.
 
There are material risks associated with investing in real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal.

IRC Section 1031, IRC Section 1033 and IRC Section 721 are complex tax concepts; therefore, you should consult your legal or tax professional regarding the specifics of your particular situation.