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Make the most of global property in an environment of rising inflation

Many market participants expect a potentially high inflation environment across the world, and particularly in the US, as the world acclimatises to unprecedented stimulus and the pending removal of strict economic lockdowns.

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Nicolas Lyle

Nicolas Lyle

Senior Property Analyst

We highlight below some key aspects of this short-term outlook for global property investments.

 

1.  Inflationary pressures expected in 2021 and 2022

“I have little doubt that with excess savings, new stimulus savings, huge deficit spending, more QE, a new potential infrastructure bill, a successful vaccine and euphoria around the end of the pandemic, the US economy will likely boom. This boom could easily run into 2023 because all the spending could extend well into 2023.” Jamie Dimon, Chairman and CEO of JP Morgan (March 2021)

 

This sentiment is echoed by Cohen & Steers, a global property and infrastructure manager. They argue in this research report that the mounting US debt burden as a result of unprecedented levels of fiscal spending related to COVID-19 is likely to drive significant inflationary pressure sooner than many investors expect. They add that the risks of inflation are potentially higher than they have ever been before.

 

Other factors include the US Federal Reserve’s (the Fed) recent policy changes, which include targeting average inflation as opposed to an absolute level of 2%. This means the Fed is likely to allow inflation to increase further before introducing measures to contain it.

 

2. REITs’ returns compare favourably with inflation historically

Reit dividend growth per share

              Source: NAREIT

Chart 1 shows that in the 14 years between 2004 and 2018, US REITs’ aggregate dividend growth has exceeded inflation every year with the exception of 2009, when dividends were cut as a result of the global financial crisis. Though not shown above, dividend growth also outpaced inflation in 2019. Over this period, average annual growth in dividends per share was 9.6% (or 8.9% compounded) compared with only 2.1% (2.2% compounded) for consumer prices.

 

In 2020, which may have been one of the most challenging years in history for global property, approximately a quarter of companies in the investment universe still managed to raise dividends by more than inflation. Almost another quarter were able to maintain dividends.

REIT returns compared to S&P 500

The chart above shows that, in high inflation periods, falling REIT prices were offset by a strong income return. In periods of low and moderate inflation, although global equity (as measured by the S&P 500) delivered stronger price returns, REIT dividends also enabled REITs to outperform global equity.

 

3.  The last period of high inflation pre-dates the modern REIT era

While historical REIT performance compares favourably with inflation, the fact that periods of high inflation have not occurred since the 1980s, the start of the modern REIT era, means assessing REITs’ performance during these cycles is challenging. There were periods of high inflation in the US in the 1970s and 1980s, when annual inflation reached 13%, but since 1990 the inflation rate has rarely moved above 3%. This has been the case for most developed market economies.

 

Looking at the historical inflation rate since the inception of US REITs in 1972, as illustrated below, the US has experienced two periods of high inflation, and several periods of moderate or low inflation.

Annual inflation rate
4.  Cyclical property subsectors are well positioned to take advantage of higher prices

Not all global property subsectors have the same level of pricing power in an inflationary environment. REITs and listed property companies that can adjust their prices quickly should enjoy most of the benefit. This implies subsectors with the most short-dated income will see the highest upward revisions to rental revenue (despite any structural forces). On the other hand, subsectors with the longest-dated, most secure income are least likely to benefit in this environment, despite usually having inflation-linked lease escalations built into lease agreements. This is clarified in the table below:

Property subsector review
Conclusion

Previous periods of high inflation were accompanied by rising interest rates, which in turn sent capital values lower (higher required risk premium). However, in 2021-2023, central banks have pledged to keep rates low, potentially removing this threat while allowing the economy and therefore global property companies to rebuild their earnings and cash flows, providing income growth.

 

Real assets’ history of equity-like returns shows their ability to deliver attractive returns over longer market cycles, despite inflation. Notably, the past three decades have been characterized by low inflation, indicating that high inflation is not necessary for real assets to deliver attractive long-term returns, as shown in exhibit 2 below, published by Cohen & Steers.

Real assets have delivered competitive returns

History proves that an environment of gradually rising prices (inflation), along with measured interest rate increases, supports global property returns. This is because market rental rates also rise, reflecting economic growth. Most global property companies’ cash flows tend to lag this growth by 1-2 years due to lease lengths, making global property (in aggregate) a late-cycle beneficiary.

 

Our positive stance on global property will reverse if economies overheat in the rebound and the world’s leading central banks are forced to raise interest rates sooner than guided.

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