Is commercial real estate a good investment amid inflation?

CRE is one of the biggest asset classes in the US

Is commercial real estate a good investment amid inflation?

Given economic uncertainties amid inflation, it’s often difficult to assess the state of the markets. In times like this, one turns to experts to provide an outlook. 

To that end, Mortgage Professional America sought insight from Ian Formigle (pictured), chief investment officer at CrowdStreet, one of the largest online CRE investing platforms. He spoke to MPA after a year that saw private investors as the most active buyers of commercial properties.

“One of the things that we see in real estate and why we believe in commercial real estate as a component of a diversified portfolio is 1) it’s a non-correlated asset. Historically to publicly traded equities, and when we study indices such as the NCREIF and NAREIT index and you look at correlation co-efficients to S&P over time, it has a low correlation – like .20 negative correlation to bonds and so forth. So it provides diversification in a portfolio.”

According to its website, the objective of the NPI (NCREIF Property Index) is to provide a historical measurement of property-level returns to increase the understanding of, and lend credibility to, real estate as an institutional investment asset class. The NPI goes back to fourth quarter 1977 and is comprised exclusively of operating properties acquired, at least in part, on behalf of tax-exempt institutions and held in a fiduciary environment. The other referenced index offered by Nareit “…serves as the worldwide representative voice for REITs and real estate companies with an interest in US real estate. Nareit’s members are REITs and other real estate companies throughout the world that own, operate, and finance income-producing real estate, as well as those firms and individuals who advise, study, and service those businesses, according to the Nareit website.

It’s big and ubiquitous

And then there’s the sheer size of the market as another consideration: “The second thing we look at is the size of the market,” Formigle said. “If you look at the total capitalization of real estate writ large across the world, it’s the third-largest asset class. You have bonds, cash and real estate. You look at all commercial real estate and all residential forms of real estate, total capitalization is more than all equity markets across the world. As an alternative asset, when it’s that large and ubiquitous, it also begs the question: Why not? If you’re not investing in it, why not? It’s one of the biggest asset classes in the world.”

His advice is part of the platform’s ideals, he suggested: “Third, we also say that as it provides this non-correlated return, we’re proponents of modern portfolio theory in general. We generally like the idea of adding non-correlated assets to a portfolio.”

A hedge against inflation

From a historical perspective, such investing is a good bet: “There was a study that was published by Green Street that went back and looked at eight instances of above-average inflationary periods between 1973 and 2021,” Formigle said. “REITs on average had returns that were 9% above equities, 13% above the inflation rate. The reason why is that underlying fundamentals of real estate are basically generated from rents. Rents tend to track with inflation so as everything goes up in price – rents are part of CPI, they’re 40% of CPI – so if inflation is spiking that usually means rents are spiking which then means that net operating income will increase. Usually revenue is higher than expenses, expense can increase on a project as well as inflation hits, but net operating incomes tend to increase, which provides some buffer against inflation.”

The Green Street Commercial Property Price Index decreased by 0.2% in March, according to the latest report. The index has fallen 15% since property prices peaked a year ago, Green Street reported. “Transaction volumes remain low, but our estimates put the bid price about 15% lower than it was a year ago,” Peter Rothemund, co-head of strategic research at Green Street, said in a prepared statement. “The change in pricing varies by property type. Office has seen the largest price declines, where even high-quality properties are down 25% over the past year.”

In summation: “Those are the three things that we see,” Formigle said. “It’s a large, ubiquitous asset class which also, by the way, is heavily invested in by institutions, endowments and things like that. Even in times of inflation, it can provide a decent hedge.”