There’s a great deal of uncertainty surrounding inflation, but commercial real estate can be a stable investment you can make to protect against inflation. U.S. consumer prices have increased up to 6.2% over the last 12-month period. It’s the highest increase in a 12-month period since 1990. When it comes to consumers, this means food, gas, clothing, and other goods will be at an all-time high.
For those investing in real estate, this will mean the expense of owning, constructing, and operating current properties and financing transactions in real estate will increase as well. But, although this may be the case, there are still ways you can ensure you’re still in profit mode during periods of commercial real estate inflation.
In this post, you’ll learn some solid ways of how to profit despite inflation in real estate.
What Is Inflation?
Inflation is an overall price increase and fall in money’s purchasing value. What this basically translates to is an increase in ordinary expenses, such as:
- And more
These basic essentials can actually cost much more than what you’re accustomed to, in some cases, and without a relative work-related income increase.
Investing in “hard assets” like precious metals, gold, oil, and other natural resources has been a protective investment outlet historically to both turn a future profit and help protect against inflation. When there’s an economic shift, investors often look for alternative investments, such as commercial real estate for their standard public stock, cash, and bond portfolios.
Why Commercial Real Estate Investing?
Commercial real estate can be a very profitable industry, which is why a lot of businesses make large investments in it. They have a good real estate profit margin. As the economy begins to improve, the demand for commercial office space will start to increase, which in turn leads to increasing property value.
How to Profit in Commercial Real Estate During Inflation
Here are some steps you can take to stay in profit despite inflation in real estate:
1. Set Clear and Concise Goals
When you invest in commercial real estate, it’s essential that you have a clear and concise goal in mind on the profit you’re looking to make with the investment. Determine if the purchase will be for re-sale or rental purposes. Figure in things such as:
- Renovation costs
- Operating costs
- Tax expenses
Calculate how much income you expect to make to determine the profit potential of any property.
2. Make a Time Investment
For any commercial property to start generating a steady income stream, it’s essential that you invest enough time in property management. This may include responding to the requests and needs of the tenants in a timely manner. A timely tenant response as well as property maintenance will lead to long-term leases or contracts and a stable investment property income.
3. Streamline Fund Management
While investing in commercial real estate, profits can be increased by lowering the costs of management and administration. Lowering these costs will reduce expenses passed on to investors, and can be accomplished in a variety of ways, like:
- Automating processes
- Streamlining operations
- Reducing hours and human resources spent on these areas
4. Include a Commercial Lease Rent Escalation Clause
When you include a rent escalation clause in the lease agreement of your commercial property, it’s a solid way to hedge against inflation. There are a few general methods you can use to increase your commercial real estate rates with a rent escalation clause. These include:
- Percentage escalation
- Fixed escalation
- Consumer price index escalation (CPI)
Since the increase in rent is based on the consumer price index, CPI escalation will be fixed to inflation directly. Landlords can maximize the profit they earn through CPI escalation clauses when inflation is high.
5. Bank on Property Scarcity
It makes sense that space will continue decreasing. As more buildings, apartments, and homes are built to raise the real estate supply, it contrarily creates scarcity of space also. More companies will continue opening and growing, therefore the need for commercial real estate will also continue to increase.
In dense commercial centers and real estate markets, limited supply and high demand contribute to the appreciation of real estate prices during inflation, which is a win for investors. Therefore, if price increases exceed the rate of inflation, the relative return will stay mostly positive.
6. Increase Tenant’s Operating Expenses Share
As inflation increases, the cost of operating a commercial building generally increases. With a commercial lease arrangement, the tenants usually have a pro-rata share of operating costs. This share is based on how much square footage is occupied by the tenant.
To ensure profits and stay ahead of the curve, landlords are able to raise the share of operating expenses of the tenants. These expenses typically include:
- Real estate taxes
- Building maintenance
However, expenses like these must be identified clearly in the lease with an escalation clause, letting the tenant know there may be potential rate increases.
7. Invest in a Property When There are Low Interest Rates
Investors can hedge against inflation by purchasing a property. They can keep their money protected by taking advantage of low mortgage rates (i.e. 3.1%) for a fixed 30-year rate mortgage, in addition to benefiting from appreciation.
When a commercial property is sold or rented, it can shift the increased consumer cost to either the buyer or tenant, which ensures the investor will earn a profit.
Also, by purchasing and holding a commercial property, the property will begin to appreciate and become more valuable over time.
8. Determine your “Real Return”
As investors explore their options, they need to remember that any income they generate from bonds or other types of fixed income tools should factor the inflation rate to figure out what their “real return” will be. Basically, this will be the gross return. For instance, if you’re earning a 5% return on a bond and there’s a 2% inflation rate, then your real return will be 3%.
By factoring this into a potentially high inflation risk environment, investments that could generate higher yield become more appealing if they’re able to be done in a low risk environment. In commercial real estate, when sourcing investments, professionals will have the competitive advantage in identifying opportunities that can create a strong risk-adjusted yield.
9. Make a Multifamily Property Investment
During inflation periods, the cost of building rental properties grows exponentially (i.e. the increasing cost of lumber). This will fuel the shortage of available and affordable properties to purchase or rent.
Market conditions like these create profitable and futile ground for investors. Investors have the chance to earn adjusted to inflation rental income and also enjoy the advantages of property value appreciation.
When it comes to the economy, inflation is to be expected, even inflation in real estate. There are irregular present economic patterns, which can make it hard to predict inflation periods. Investors require an understanding of the different mechanisms of this occurrence. EXtrance can help you unlock the possibility of limited partners with our secure and easy platform that provides connectivity and transparency to what would otherwise be an arena of uncertainty. When you’re informed and knowledgeable about these things, it makes you a great investor. Contact us today to start your free trial today.