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Real Estate Is a Safe Haven From Inflation — But Only When Landlords Have the Upper Hand

“Nobody worried about inflation, even a couple of years ago,” said Nuveen Real Estate’s Shawn Lese.

Whether or not real estate is an inflation hedge comes down to a landlord’s ability to raise rents. 

Right now landlords have pricing power over tenants in the healthiest cities where empty properties and apartments are scarce. According to Nuveen Real Estate’s latest report, published Monday, landlords have the power to raise rents in the 50 largest cities in the U.S. and Europe, where vacancies are below-average. The most attractive real estate subsectors in these cities are industrial, residential and, perhaps surprisingly, retail in the U.S. In Europe,  industrial, residential and office real estate are the industry sectors with the lowest vacancy rates. Nuveen, however, stressed that retail in Europe and office space in the U.S. both had above average vacancies. With little ability to up raise rents, these sectors may not protect investors from the pain of inflation. 

Amid rising rates of inflation, Nuveen Real Estate argues that rents and property values are connected to rising consumer prices. Between 1994 and the end of 2021, growth in rent — specifically real estate net operating income — was highly correlated with inflation. 

With more demand for real estate than supply, landlords have leverage to hold out for premium prices for their properties. Nuveen argues the real estate sector has a unique ability to out-price the market during inflationary periods. 

“Real estate operates as a good hedge against inflation because essentially you’re able to capture the inflation through the higher rents,” Shawn Lese, chief investment officer and head of funds management for Nuveen Real Estate’s nearly $90 billion Americas platform, told Institutional Investor.

Higher rents lead to higher cash flows and higher property values, Lese said, adding that the investments can rise to match or even surpass inflation. 

Ted Wozniak, U.S. head of asset management at SEI, said he generally agrees, but stressed that real assets and real estate have significant shortcomings. With owner’s equivalent rent being 25 to 30 percent of CPI, it’s logical that real estate would be correlated to inflation, Wozniak told II in an email. “However, the challenge is that it is ONLY a component,” he said.

Wozniak said TIPs [Treasury Inflation-Protected Securities], commodities, real assets, and real estate all provide protection, but are not “perfect independently,” he said. 

“I believe inflation protection should come in a more comprehensive strategy, which takes into consideration various components that deliver inflation beta more closely correlated to CPI,” Wozniak said. 

Institutional investors have been increasingly making allocations to the real estate market for the past decade. Lese said five factors have driven the flows: income, capital appreciation, volatility management, diversification, and hedging inflation. 

“For the 25 years that I’ve been doing real estate, [real estate’s role as an inflation hedge] has always been point number five. Now, it’s point number one or number two,” Lese said.  “Nobody worried about inflation, even a couple of years ago.” 

However, Nuveen warns that higher energy costs and supply bottlenecks may leave firms and individuals with less money to spend on real estate. 

For real estate investors, new leases in inflationary environments allow them to take advantage of rising rents. Even on long-term leases, Nuveen highlighted that contracts can include a rent escalator tied to inflation. 

“The current run of inflation is partly attributed to an economy running at full speed, which also increases the demand for real estate across the economy, driving rents upward,” the report said. “This can be witnessed across property types, in particular apartment rents and industrial/logistics rental growth.” 

Nuveen notes it believes investors should “play the long game” to cash in from real estate’s positions as an inflation hedge. While real estate investments may be a relative safe haven for investors in this inflationary period, the report reminds investors to gain exposure to a wide range of property markets and sectors, particularly sectors with strong fundamentals and demand tailwinds. 

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