Inflation is the risk factor investors are watching most closely this year—but each type of property has unique nuances in terms of interaction with inflation.
That’s according to John Chang, senior vice president and director of research services at Marcus & Millichap. He says office buildings have a general resistance to inflation because their values tend to align with replacement costs and they are marked to market based on tenant turnover. Some properties may also have inflation escalations built into the rental agreements. On a scale of 1 to 10, meaning little or no inflationary risk, Chang ranks the risk of the office sector between three and five.
Multi-tenant retail falls into the same category, he says, thanks to long-term leases that could have escalators tied to sales. Single-tenant properties typically don’t have such escalators, but the risk depends on the tenant, he says; Chang also ranks them in the three to five range.
Market-rate senior housing can recalibrate based on turnover, and government programs like Medicare or Medicaid also typically adjust for inflation. The sector has the ability to mark-to-market, so the inflation risk rating is between three and four.
The inflation risk for medical practices is low, Chang says, in the range of two to four. Meanwhile, the multi-family and self-storage sectors have enormous resistance to inflation since their rents are frequently adjusted to the market.
The most inflation-resistant type of CRE property—with the possibility of changing the rates every day—is hotels, at range one to two.
“Periods of high inflation tend to be relatively short—a few years or less,” says Chang. “This should not be the main driver of investment in commercial real estate, but it could slightly influence investors’ decisions. Real estate is generally a long-term investment with multi-year holding periods, so while you factor in inflation and other short-term risks, investors need to keep their eyes on the horizon.