How Inflation Could Impact Retail Real Estate

While inflation can be advantageous when you own real estate that allows for rentals, it can also be problematic when it affects other areas of your life and your portfolio. While real estate is often used as a hedge against inflation, there's a possibility that the inflationary environment can cause retail business owners to close or change locations. Before you invest in retail real estate, you should know how inflation impacts this type of investment.

Inflation Hurts National Currencies

When inflation is high in an economy, the average consumer will need to pay more money to purchase everyday items, which leads to a decrease in purchasing power among these individuals. Purchasing power refers to the value that can be obtained from one unit of currency. During inflation, purchasing power decreases, which means that it increases when inflation drops.

To better understand the effects of a lower purchasing power, let's say that you pay $400 per month for groceries in a standard economy. If a financial crisis has just occurred, consumers everywhere may be starting to spend less money on goods to add funds to savings during uncertain times.

However, businesses will still look to make a profit. When consumer demand drops, profit margins also decrease, which is when businesses begin to increase their prices. These price increases can continue as businesses begin to pay more for labor and raw materials during the financial crisis.

All of these issues cause inflation to increase by a considerable amount. If the inflation rate is 9% for the year, this means that goods that would have cost $1 in the previous year will cost $1.09 today. Your currency has now lost around 9% purchasing power, which means that your grocery bill will be $436 per month.

Retail Real Estate as a Hedge Against Inflation

Like most types of real estate, your retail investment can be used as a hedge against inflation since property values usually appreciate over time. When the purchasing power of a dollar drops, real estate will continue to increase in value since businesses will need space.

By owning retail real estate during a period of inflation, it's considered a hedge against inflation when it comes to your portfolio. If you decide to sell the property, you can sell for an amount that's higher than what you originally paid for it.

Retail real estate functions like gold in inflationary environments. Along with prices being driven up organically, you can choose to increase lease renewal rates during inflation, which allows you to earn more income and gain higher returns.

When you invest in a property that has already been developed and has been around for a considerable amount of time, the interest rate you obtain on any loan to buy the property will likely be higher during inflation. However, using retail real estate as a hedge against inflation isn't as effective when you invest in properties that are currently being developed or plan to be under development.

While rising interest rates allow your property value to grow while your costs remain the same, inflation usually leads to higher costs on materials and labor, which can be an issue when you're attempting to construct a new retail store. Since new structures can't be easily built, demand for existing retail structures will increase, which should boost the property value.

Selecting the Best Property

Selecting the right piece of retail real estate is challenging and may depend on the market you're in. During COVID-19, retail real estate struggled since more consumers were making their purchases online.

Since that time, many consumers have moved back to in-store purchases. While the pandemic was bad for retail properties, the resulting economic conditions haven't hurt this sector as much, meaning that the effects of inflation are currently neutral or positive.