Relax About Inflation (Even Though Property Isn't A Hedge)

You can relax about inflation. Maybe.

As U.S. consumer prices rise at their fastest annual rate since 1990, up 6.2% in October compared to a year ago, and with UK inflation at 3.1% and expected to hit 5% by April 2022, M&G played down the dangers for commercial real estate.

The firm released its Global Outlook report just days after Bank of England governor Andrew Bailey confessed he was “very uneasy” about the UK inflation risk.

M&G Real Estate’s global outlook took a cool approach, adding that real estate offers a defensive play against rising inflation.

“Even in a scenario of heightened inflation persisting, property offers protection and a potentially promising medium to long term investment play on the strength of its characteristics as a real asset,” the report said.

“Pent up demand and significant levels of household savings in Europe bode well for the economy. Inflationary pressures are already visible in the form of higher raw material/construction costs, though this could be a temporary phenomenon caused by a rapid resurgence in demand and problems with supply chains,” it added in a statement.

Speaking on a conference call to introduce the report, Head of Property Research Richard Gwilliam said: “We have historic data to demonstrate that real estate is well placed to protect from long-term inflation. If inflationary pressures become more than just transitory then we are likely to see interest rate rises, which will at some point put pressure on property yields, but we have some buffer there, quite a high spread.”

“I didn’t use the word “hedge”, but [real estate] offers protection in the long term if we have persistent embedded inflation. That’s when property comes through.

“If there is economic weakness then property generally doesn’t perform well because there is a strong link between performance of real estate and the performance of the economy.

“But now we’re seeing a strong economy, with growing evidence this is turning into demand-pull inflation as demand-side pressures push up prices. That is sort of good inflation. But we’re not of the view that property is an inflation hedge, although it is a protection.”

Investment Property Forum’s 2011 analysis of the 2007-2009 Great Financial Crash concluded property was not a hedge against inflation, but was correlated with economic growth.

“While UK property delivers positive long-run real returns, it is not, in most cases, a hedge against inflation, where a 'hedge' is defined strictly as moving at the same time as inflation, or reacting to it, rather than merely keeping pace with it over time,” the report said. “This may depend upon the underlying economic conditions and type of inflation. Property does hedge against economic growth and, consequently, is useful for matching future assets to liabilities where future liabilities are nominal GDP related ie wages.”

M&G also highlighted the growing strength of the sustainability agenda and opportunities to buy in the distressed retail sector.

“We are witnessing a range of trends emerging as the relaxing of economic and social restrictions give way to higher consumer and occupier demand in certain locations but there is still tight supply, lockdowns and supply chain issues in others. The key is to identify winners in this environment,” M&G Real Estate Head of Investment Strategy Jose Pellicer said.