Commercial real estate provides a unique inflation hedge for the well-diversified investor for two primary reasons. First, the costs of constructing new structures move directionally with inflation. As prices increase for major inputs like wood, copper, and labor, the values of newly constructed real estate assets increase as well. Value increases for newly constructed assets also result in price growth for older assets; a rising tide of prices lifts all boats.
The second reason commercial real estate serves as an exceptional hedge against inflation is due to an operational characteristic of the U.S. commercial real estate market: fixed-term leases. Across all real estate classes, lease structures include set expiration periods where landlords can renegotiate rental rates with tenants. Landlords also hold the right to remove tenants who disagree with increasing rates. So, when prices rise, landlords can easily increase rental rates to keep pace with even the most troublesome inflation.
While fixed-term lease structures are common across all classes, multifamily real estate provides one of the best hedges against inflation. Multifamily leases are typically structured with six to twelve-month terms. These relatively short-term leases allow multifamily investors to capture rapid rent increases when confronted with high inflation. These benefits to multifamily investment can be seen in the historical price growth of assets: during the past three decades, the average annual growth rate for multifamily asset values has more than doubled the annual rate of inflation in the U.S. Fixed-term leases along with price responsiveness relative to input costs allow commercial real estate investors an unparalleled tool to combat inflation risk without compromising yield.