Is property the ultimate inflation protection?

As investors search for inflation ‘protection’, bricks and mortar make a powerful claim.

The best defence against inflation could lie on your doorstep. Picture John Grainger

Inflation concerns continue to fan fear in the investment markets, with advisers putting gold, inflation-linked bonds and even bitcoin forward as “inflation protection”, but the answer for the fearful may well be something closer to home – property.

Despite a consensus among economists that the inflation breakout this year will be “transitory”, the US continues to print monthly Consumer Price Index numbers near 5 per cent. Meanwhile, in our own market there is growing concern that the most commonly used inflation figures are misleadingly low. That’s because the CPI does not include house prices, which are set to rise by 20 per cent this year.

For investors (especially older investors), the key concern with any inflation across investment markets is the erosion of purchasing power and the need to keep investment earnings well ahead of inflation to sustain “real ­income”.

One Australian fund manager – Justin Blaess at Quay Global Investors – is a long-term listed property investor but found he could not access hard evidence that property did actually stand up against other investments in periods of higher inflation, so he did his own investment research.

With our local listed market dominated by some very large property companies (where development and fund management profits skew the data), Blaess instead looked at the US market over the last 50 years.

Blaess is the first to declare a vested interest here, but the numbers are compelling. He says property wins when inflation rises and it wins big when inflation takes off. (He analysed US REIT and S&P 500 real and nominal returns by constructing indices for when headline CPI was both less than and greater than 3 per cent and in increasing increments of 1 per cent.)

He found inflation has more often than not been above 3 per cent over the last half century: when inflation is in the 3-6 per cent range, listed real estate “generated more than double the real return relative to equities”.

No wonder Blaess believes that investors in property – or in listed property companies – could actually benefit from inflation.

But is the research applicable to Australia? Blaess says it is highly relevant to our listed property trusts anchored by traditional tangible assets. He says the hot spots are segments of the market where rental terms are shorter, such as selected retail developments, storage facilities and data centres.

As for retail direct property investors, who own a nearby house or an apartment across town, Blaess says they “would be in a good position – owning residential property where the rent is reviewed regularly rather than, say, every five years in the commercial markets”.

Despite the constant focus on exceptionally low interest rates and their impact on property ­prices, Blaess says a key issue in property is replacement costs. When inflation hits the wider economy, he says property investors are in the enviable position that they can pass on higher ­labour or material costs compared to other sectors.

“Investors in real estate – both direct and listed – can benefit from a higher inflation environment, particularly compared to global equities investment,” says Blaess.

Nobody knows if the current bout of inflation is going to become a major headache in the months ahead, but investors are not waiting to find out.

The gold price has been climbing in the past month. Similarly, bitcoin has rebounded to $US50,000.

In the local bond market, the government’s $3.25bn auction of 10-year inflation-linked bonds this week was oversubscribed.

But for many investors the most practical inflation “hedge” might just be a house.

Originally published as Is property the ultimate inflation protection?