Getting back to the future: Inflation vs Deflation

Is property a good inflation hedge?

With inflation around the world rising, many investors are wondering if property makes a good inflation hedge. Unfortunately, the answer to that is not as simple as ‘yes’ or ‘no’, and instead an ambiguous ‘sort of’ might be a better response.

Inflation is on the up. This month the OECD revised up its inflation projections across G20 nations for the year to 3.7% from 3.5%, and for 2022 to 3.9% from 3.4%. In addition, the UK posted the biggest jump in annual inflation since records began last month, with CPI accelerating to 3.2% in the previous 12 months to August, up from 2% in the year to July.

On a recent webcast, we discussed the outlook for inflation and how investors can protect themselves, or ‘hedge’, against rising prices.

It’s no surprise that attention has turned back to the classic question: Is property a good inflation hedge? Rather unhelpfully, the answer to that is… it’s complicated. There is a correlation between property and inflation, and there have been periods of time in which property has meaningfully outperformed inflation, however, there have also been periods of time that is has not.

Property is a broad church, and as the recent Covid-19 crisis has demonstrated, different sectors perform differently under stress, which makes it tough to determine whether it’s a good inflation hedge.

During the pandemic, leisure and retail suffered enormously, as businesses that typically rely on footfall and in-person customers were forced to close during lockdowns. Some retailers experienced a partial recovery, pivoting to ecommerce as customers turned to online shopping for their purchasing needs, however, hospitality venues like restaurants struggled, with even those making use of takeaway delivery apps like Deliveroo barely making ends meet. Leisure venues like bowling alleys, meanwhile, were entirely at the mercy of the lockdowns and relied heavily upon government coronavirus packages like the business rates holiday and the eviction moratorium to survive.

In comparison, industrial properties like warehouses have been an unmitigated success for investors as traditional retailers moved online, and mega e-commerce giants like Amazon swallowed up an even greater market share. The popularity of online shopping was only accelerated by the Covid-19 pandemic, and with the use of e-commerce predicted to become even more commonplace, further storge space will inevitably be required, driving a renewed demand for logistics space. The sector has such a bright future that I imagine it could become one of the top performers in the next five years.

When it comes to asking whether investing in property is a good inflation hedge, income security is an area often not given enough strength in the debate, and yet there is nothing more frustrating for property investors than seeing capital growth eroded by a loss of income. Let’s consider retail property for a moment; if you’d have bought a shopping centre five years ago, the rent today would be approximately three-quarters of what you would have received when you first bought the property. Not dissimilarly, if you happened to be the landlord of a space occupied by Travelodge, you’d have had a really challenging year. Last June, the hotel chain gained approval for a company voluntary arrangement, allowing it to withhold rent to shore up its finances.

Away from changes to our shopping habits, the major trend that came from the pandemic was a shift to home working. Interestingly, this seems to have had a considerably bigger impact on residential property than it has on offices.

Fearing the residential property market would fall off a cliff, the government implemented the stamp duty tax holiday, which turbo-charged the market. In addition, with people spending more time working from home, many wanted bigger houses with office and garden space, and felt able to move further away from their place of work, as a more permanent shift to hybrid working looked likely. As a result, the average UK house price has increased an inflation-beating 8% over the year to July 2021, according to the latest available data from the ONS, up £19,000 from the same period in 2020.  

Office buildings, meanwhile, have seen very little in the way of rent changes despite being considerably emptier since the onset of Covid-19. Despite staff often only coming into the office a few days a week, tenants have typically decided not to downsize, as offices are fundamentally collaborative environments and people often go in on the same day. The lack of people physically present in office buildings has also had little effect on how people value them, with foreign investors, who tend to favour offices, keen to continue to put money into big ticket and iconic buildings.

Property isn’t the worst place to be if you want to hedge your portfolio against inflation, but it’s far from perfect. With that said, there are still opportunities in the sector, particularly in logistics, while it’s worth being wary of other areas, like long-income markets, which conceivably could see a tenant unable to pay rent.

Investors should remember that the value of investments, and the income from them, can go down as well as up and that past performance is no guarantee of future returns. You may not recover what you invest. This document is not intended to constitute financial advice; investments referred to may not be suitable for all recipients. Any mention of a specific security should not be interpreted as a solicitation to buy or sell a security