To protect against inflation, big investors are trading the value-add model for a core investment strategy.
This year, inflation has become a top concern for investors. Institutional capital and major funds are planning ahead by shifting from a value-add or short-term hold investment strategy to a long-term hold business model.
“On a short-term hold, it is very difficult to make any meaningful money when the cap rates are so low. You are only going to see revenue increasing with inflation, you have to hold the property for a long time to see growth,” Jahn Brodwin, a senior managing director in the real estate practice at FTI Consulting, tells GlobeSt.com.
At the center of the longer-term strategy is long-term debt, usually at 10 years. Because the value of the dollar decreases with inflation, investors with long-term debt are paying the loan off with cheaper money. “If you can secure 10-year money with a fixed rate when you are at year seven, eight, and nine, you are paying back debt with cheap dollars,” says Brodwin. “If you can lock in long-term low-interest rates followed by a period of inflation, while rents are climbing at inflationary rates, your debt is staying flat.”
The multifamily market is a perfect asset class for this strategy because the rent structure also provides a hedge against inflation. “Multifamily is great inflation protection because they re-price every year,” says Brodwin. “So, if there is an extended period of inflation, multifamily becomes a good inflation hedge, compared to office or retail with longer-term leases.”
Apartments are also historically resilient during times of economic dislocation. “The one thing that we know for sure is that people need a place to live,” adds Brodwin. “So, multifamily has always been viewed as a safe bet. In exchange for the safe bet, you have to be willing to accept a lower return.”
While institutions are holding onto assets for longer, they aren’t necessarily changing to a core or core-plus strategy. “Clearly, there are many funds that are in the buy-fix-sell mode, but there is a lot of money looking for a home,” says Brodwin. “Capital is focused on buying assets that provide inflation protection. It is a safe bet, and when you have all of this uncertainty surrounding other asset classes, there is a flight to safety.”
Institutions are securing long-term debt at low-interest rates as quickly as possible, while rates are still low. Many experts have visions of rising rates in the future. “We are in a historically low-interest-rate environment. The expectation is that this isn’t going to last for very much longer,” says Brodwin. “There is less and less purpose to keeping interest rates artificially low.”