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Commercial real estate is a well-known inflationary hedge. During periods of inflation, investors turn to real property because it’s a tangible asset with stable income that can be adjusted to offset rising prices. It’s absolutely a safe haven—but it isn’t completely immune to inflationary pressure.
Inflation increases the cost of capital, development and building operations, often leading to diminished commercial real estate investment returns. In 1990, the last time that the inflation rate exceeded 5% (the baseline for a high-inflation environment), commercial property returns fell nearly 10%. Inflation hadn’t again exceeded 5% until the second half of last year.
Experts initially dismissed the rising consumer price index as a transitory event and a sign of healthy economic recovery driven by the rapid rebound in consumer demand after the pandemic. In December, however, US Treasury Secretary Janet Yellen was among the first to deliver the bad news: “I am ready to retire the word transitory,” she said. By March, the rate of inflation reached a staggering 8.5%, the highest since 1981, when then Fed Chair Paul Volcker famously increased interest rates to nearly 20% to stop runaway inflation.
While the current Fed will certainly have a similar response this time around—with the expectation that rates will rise at least six times this year—the world is a different place today than it was in the 1980s. Technology is playing a key role in combating inflation and offsetting rising costs, and investors leveraging technology as part of a commercial real estate strategy will mitigate risk in an already inflation-resilient asset class.
Technology is deflationary.
Commercial real estate may be the long-time favored inflation hedge, but technology wields a similar power. Technology actually has a deflationary effect on the economy, and it’s so significant that the economy can absorb small levels of inflation without any intervention. Prior to the pandemic, the US economy had been operating essentially inflation-free, despite the Fed’s aggressive quantitative easing strategy that sought a 2% inflation rate annually. Experts have attributed this long-term deflationary environment to the widespread adoption of technology and automation.
With technology, businesses achieve optimal efficiency. Production can scale to meet both current and future demand, in effect, suppressing costs over the long term. In commercial real estate, effective productivity streamlines operations to drive down costs and enhance returns, making technology a crucial part of a defensive investment strategy during an inflationary period.
Looking at technology performance as a sector offers some insight. The 1990s is the only historical example that we have of how technology might carve a different path for inflation today. From 1990 to 2002, technology stocks outperformed the rising interest rate environment, showing the stability of the sector when market fundamentals change. This year, the same trend is unfolding. Technology stocks have continued to outpace the market through incremental rate hikes. “I think it's a rush to judgment, quite frankly, that tech stocks, in particular, are weakening just because, or will weaken because of the higher interest rates,” Brian Belski, Chief Investment Strategist at BMO Capital Markets, said in a recent interview about the current inflationary environment.
Commercial real estate has not fared as well. After growing 43% in value last year, REIT stock prices have trended downward in 2022 by about 5%. PBMares suspects that investors may be shifting away from commercial real estate investment due to higher operational costs and higher costs of capital, both in new acquisitions and refinance deals.
However, technology can mitigate those investment risks through efficiency. “It's going to cause all companies to be even more efficient. So, the return structure of these companies in the United States in terms of return on assets, return on invested capital, return on equity, are really driven by this efficiency that's coming from technology,” Belski said. These benefits will ease the inflationary impact on returns in commercial real estate.
Technology amplifies opportunity.
As a deflationary tool, technology drives production and operational efficiencies that put downward pressure on pricing, but technology can also be used as a part of the strategic agenda. Through automation and data and analytics, commercial real estate investors have been able to make better investment decisions, access new revenue streams and be more strategic about property operations, according to research from EY.
The industry has focused on using technology as a means of lowering costs through operational efficiency. Although that is a major benefit, technology also drives better investment strategy, and that is potentially the more valuable utilization over the long term. According to an EY survey of commercial real estate professionals, 69% of respondents said that using technology as part of the strategic agenda was the highest priority. The second highest priority was improved efficiency and reduction in costs.
Commercial real estate firms are integrating tools that accomplish these goals into routine business practices, and software programs like Northspyre are driving this conversation.
Through a combination of automation, data, and predictive analytics, Northspyre provides intelligent insights that can vastly improve the outcome of a project. It, of course, produces financial benefits—the software can reduce cost overages by 21% to 66%—but it also produces more predictable outcomes on projects to shape and successfully execute the business strategy. This is done by automating administrative tasks; extracting essential data from documents, like emails, contracts and proposals; generating monthly reports; and delivering financial warnings that decrease overages.
These are the kind of tools that investors need to hedge inflation today, and the vast majority of CRE professionals (78%) are currently rethinking their technology strategy in response. While efficiency was the main goal of technology adoption in the pre-2020 era, today, professionals favor technologies that are creating and managing opportunities and unlocking real value.
During a period of inflation, every dollar counts. While the rate of inflation started to slow marginally to 8.3% in April, most experts agree that we will end the year with an inflation rate of around 7%. As Yellen said in December, this is not a temporary issue. Commercial real estate players will need an active strategy to respond to rising prices and protect return profiles, and technology is proving integral to the solution.
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