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To Inflation and Beyond

August 09, 2022 | ,

Four-line chart showing rent growth in various sectors of real estate. Chart subtitle: Industrial and multifamily rent growth has outpaced inflation; retail and office have not kept up with increasing replacement, capex, and maintenance costs. Chart visual description: Y-axis shows Real Rent Growth, ranging from -15% to +10%. X-axis shows years from 2001 to 2022. MultiFamily line is green, Industrial line is brown, Office line is blue, and Retail line is slate. Chart data description: Since 2020, both office and retail have declined, though both experienced a slight period of growth in 2021. MultiFamily declined during the 2020 downturn, increased to a peak in 2021, but has decreased this year. Industrial has held relatively stable and though it declined in the pandemic, has nearly recovered. Chart sources: CoStar, JP Morgan Chase Research as of June 30, 2022. Real rent growth is defined as the year-over-year change in property rents less inflation.

Real estate as an asset class is not immune to the effects of inflation and rising rates, but certain sectors within real estate can help investors manage through the volatility. Typically, inflation manifests itself within commercial real estate in the form of higher prices for construction materials, labor, and land. Since the onset of the pandemic, the Producer Price Index for Construction Materials, which measures the average price change of building materials over time, has skyrocketed by over 50% as of June 30, 2022.¹ These rising development costs and value-add expenditures create a headwind for real estate valuations, diluting the value of incremental rental income. However, as inflationary pressures continue to weigh on economic growth, real estate should be well positioned as a solid, though imperfect, inflation hedge. Multifamily and hotel properties benefit from the flexibility of shorter-duration leases that allow property owners to reset rents in line with market levels. Moreover, value-add and opportunistic managers are well positioned to enter deal flow at attractive unlevered price points, extracting value from industrial and retail investments that benefit from guaranteed rent increases and tenant pass-through costs. Real estate investments are an important part of alternatives allocations at Marquette as they can help diversify a portfolio and hedge against inflation while providing attractive risk-adjusted returns.

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¹Bloomberg, Bureau of Labor Statistics, Federal Reserve Bank of St. Louis, CBRE-EA, Clarion Partners Investment Research, June 2022