Misconceptions / Finance for Dummies: No, Real Estate Doesn’t Really Protect Against High Inflation

There are preconceived notions that are espoused by professionals in the sector simply because it is their source of income. Thus, “sellers of property tax exempt products” such as Pinel or others, real estate agents, brokers and other real estate intermediaries assure you that real estate is an anti-inflationary weapon. So real estate would be a parade against high inflation.. They talk about it everywhere, they talk about it in all programs, they are picked up by all the media. What is most surprising to those who know real estate fund managers is that they themselves are not convinced. And not in vain. But at the level of contributors and contributors to the general public, nothing helps, it would be true. It doesn’t matter, everyone has their own opinion, here are a few arguments against the people’s truth. This article has absolutely no purpose to change the mind of the reader. Each person has their own opinion.

Like any investment asset, real estate is determined, firstly, by its price, the price of ownership, and secondly, by its profitability (rent). If real estate is a hedge against inflation, prices and yields must therefore rise more or less in line with inflation.

In recent years, real estate prices have risen steadily and inflation has been very low. We are not interested in this, we would like to know if the value of real estate in general increases in conditions of high inflation. The reverse could well have happened. Let’s start with real estate income, rent. Easy, rents go up with inflation! Are you so sure?

So far on paper… Real estate income is well protected from inflation

If you are a landlord, you must copy the IRL annually as specified in the lease. Oh by the way, is that really true? Oh no. However, this is the clincher: Since rents are indexed to inflation with the Basic Rent Index (IRL), real estate would be a great hedge against high inflation. The rent will rise, more or less, with inflation. Thus, donor income will be saved. In theory, we agree. Theoretically yes, but in practice I completely disagree. For several reasons:

  • Real life IRL mismatch : Annual inflation in France is currently 5.6%. IRL shows 2%. No problem, the calculation method IRL has a delayed effect of several months. Therefore, it will grow in the same way as inflation. However, the discrepancy is acceptable.
  • The increase does not apply in case of high inflation : Did you know? 30% of leases do not provide for any indexed rent revaluation on IRL. Shame. So let’s talk about the remaining 70%! Is the landlord confident that his tenant will be able to pay 5-6% more rent per year for several years? Incomes rising due to inflation are dreams of the world before, but what we are experiencing now is not the inflation taught in economics lectures. This inflation is being created from scratch by the liquidity tsunami that has been thrown in by central banks in recent years. I don’t see anything. Tenants cannot pay a 6 percent rent increase without receiving a similar increase in their income in return.
  • Rent ceilings are not revalued for inflation : In an increasing number of municipalities (Paris, Lyon, Marseille, Montpellier, Grenoble, Lille, etc.) there is a rent ceiling. These ceilings are not necessarily adjusted for inflation. So, even if the lease allows for a 5% increase in rent, the landlord may still be capped by the rent ceiling.

Despite these caveats, you consider the rent to be inflation-proof. What about the price of the item? With annual inflation of 5% in 2022, property prices are expected to rise by 5% this year. This will be the case in some cities/towns, but not everywhere.

Inflation +5%: real estate prices +5%?

If real estate is an asset that can withstand inflation, then the price of real estate should rise with inflation in the same proportion. Real correlation. During periods of low inflation, real estate prices rose sharply. Thus, from the beginning of 1999 to the end of 2018, real estate prices increased by 153%, according to the index of notaries and INSEE. At the same time, the consumer price index (inflation) over the same period grew only by 32%, or 4.78 times slower.

But do real estate prices always rise sharply during periods of high inflation? Oh no. It has been a long time since France had a period of high inflation, but between 1979 and 1984, a period of high inflation (inflation rates above 10%), the price per square meter in Paris increases very little. . Inflation minus the fall in prices during this period was even 11%, which indicates that high inflation is by no means a guarantee of property prices.

What about stone paper? SCPI?

In fact, it is significantly different. SCPI is run by professionals and mainly invests in property leased from companies. Rent repricing is no longer left to the whims of the residential real estate sector. However, for the oldest investors, we can remember that in the event of a real estate market reversal, the loss in share value can be terrible. Again, no direct link to inflation. The fall in share prices between 1994 and 1998 continues to weigh on sentiment. The real estate market is slow and follows up or down trends for decades.

Historical changes in SCPI stock price

So in the end?

Real estate is an illiquid investment that only partially allows, under certain favorable conditions, local market conditions for real estate prices and good management of rents to limit the impact of inflation when rents rise. But real estate does not seem to be a weapon against high inflation, it is in no way an inflation-indexed bond! In the event of a downturn in the real estate market, especially after an increase in interest rates, with cumulative inflation, it is even possible that this is an asset that is a source of large financial losses. Never forget that real estate is an investment with the risk of capital loss. Investing in real estate under the pretext of protecting against inflation does not really make sense.