Commercial real estate can hedge against inflation. And with Australia’s inflation at its highest since the 1990s, this makes commercial property very attractive for those looking to invest.
Commercial real estate investment is known for its high yields, long-term security and stability. But right now, its ability to hedge against inflation is why the asset class is enticing investors, who are struggling to find robust cash flow opportunities while a 7-per cent inflation rate plagues the Australian economy.
Inflation brings higher interest rates, but that mightn’t hurt commercial property returns as much as other investments. Here’s why.
The advantages of commercial property in a high inflation environment
Most commercial leasing arrangements have built-in rental escalations. These are usually annual increases and most are either pegged to inflation, the Consumer Price Index, or have fixed annual increases (usually from 1 per cent to 3 per cent). And these lease agreements are long, usually 5 or more years in length. That’s a considerable amount of security for those looking to find passive income from a set-and-forget investment.
Compare this to residential property leases, which must be renewed or extended to allow for changes in inflation (and indeed the rental market). Usually, residential leases only last for about 12 months.
High inflation can reflect an active and growing economy, with a rise in consumer spending leading to higher prices for goods and services. Perhaps too active for the Reserve Bank’s taste (because inflation reduces the value of a nation’s currency’s purchasing power), which is why central banks usually increase interest rates to slow this rate of spending.
But for commercial property owners, a growing economy benefits their commercial assets by increasing demand for their premises and their tenants’ services or products. It supports both asset value growth and rent increases.
When Reserve Banks do rise interest rates – as Australia’s has since May 2022 – commercial values are far less sensitive to these rises than residential property values. That’s because of commercial yields – something the sector is renowned for.
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Why commercial property returns can hedge against inflation
Commercial real estate yields can be anywhere from 5 per cent to 9 per cent (and sometimes even higher, depending on the market). When interest rates are high – causing higher finance costs – investors typically expect yields to fall to the lower end of that scale.
That said, a good commercial property yield in a high interest rate environment still sits at about 6.50 per cent. That gives investors a chance to earn serious cash flow, while other investors scrounge for interest earnings from term deposits and run the gauntlet of dividends from volatile shares. And when inflation (and interest rates) come back down to earth, investors are still receiving that solid yield.
The spread between commercial yields and interest rates are far higher than most other investments. Plus commercial real estate gives you comfort from a tangible asset; a bricks and mortar investment underpinned by a secure tenant and ironclad commercial lease.
Overseas investors and Australian property
Offshore commercial property investors are also finding their way on to Australian shores, as interest rates and inflation rockets in other countries compared to our own.
We saw a huge drop off in international buyers during the pandemic, with lockdowns and border restrictions keeping them out of the country. But with the pandemic now behind us, more overseas players have re-entered the market, knowing the delta between yield and inflation in Australia is potentially far more significant than the opportunities in their own hub.
Publications have an easy job of scaring off investors when interest rates are rising. But as far as commercial property is concerned, the adage of ‘invest when the news is at its worst’ may reign as a supreme strategy for those experienced players.
And hopefully for those investors looking to partake in an asset class that defies the trends of most investments during high interest rate and inflation environments.
Want robust yields during a high interest rate and inflation environment? We’ve got you covered. Get in touch with us today to hear about our nation-wide commercial property syndicates that offer a tonne of great benefits:
- Monthly cash distributions
- Regular updates about your commercial asset
- Set and forget investment
- Ability to leverage our expertise and network
- Secure returns underpinned by national and multi-national tenants
The list goes on. Contact us today to find out how you can become our newest investor, and join hundreds of Australians making ironclad returns from secure, safe and reliable commercial property investments.
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