Inflation is often a cause for concern, but it can be a positive force for commercial real estate. Inflation can increase the value of properties and improve cash flow.
What is Inflation?
Inflation refers to an increase in the general level of prices for goods and services in an economy over a period of time, which causes each unit of currency to lose purchasing power over that time period.
Inflation is generally low for commercial real estate investors because it means that their properties are gaining value over time. The higher the inflation rate, the more valuable your investment will be. For example, if you purchase an office building for $100 million and then sell it five years later for $110 million, you will have made 10% on your investment annually — even though there were no major changes to the building itself!
There are many ways that inflation will affect commercial real estate in a positive way, but one of the biggest ways that it will affect us is by allowing us to make more money off of our investments. Inflation allows us to make more money on our investments because it increases their value over time, which means we will be able to sell them at a higher price than what we paid for them originally!
How inflation affects commercial real estate
It’s important to understand how inflation affects commercial real estate. There are two main ways that inflation can have an impact:
- Inflation drives up interest rates on loans. Interest rates on commercial real estate loans are usually tied to the Federal Reserve’s policy on short-term interest rates. When inflation rises, so do short-term interest rates, which means that lenders will charge higher interest rates on loans to cover the additional risk they’re taking by lending money at higher rates of return.
- Inflation makes real estate worth less in dollars. As prices rise over time, the same amount of money buys fewer goods and services — including commercial real estate. This means that owners’ net income falls even though their gross revenue may increase because they’re paying more in operating expenses such as property taxes and utilities.
- Inflation increases rents: Rents increase as a result of inflation because landlords pass on their increased operating costs to tenants. So, if the cost of operating your business goes up by 10%, then you will need to increase your rent by at least 10% to maintain the same profit margin. In some cases, landlords may even be able to increase their rents beyond these levels due to market conditions and lease clauses.
- Inflation increases the value of cap rates: Cap rate is a measure of return on investment (ROI). It tells you how many years it takes for an investor’s money to double when invested in a property or other assets such as stocks and bonds. For example, if an investor purchases an office building for $1 million with an annual net operating income (NOI) of $100,000 per year and sells it after five years for $2 million, his ROI would be 50%. That means that he earned $1 million from his original investment of $1 million in just five years instead of waiting 20 years before doubling his money at a 10% annual interest rate compounded annually;
As the inflation rate increases, Commercial property and great deals of real estate will be on the rise as well. The demand will reach its peak as more people invest in apartments and commercial land. Real estate investors are looking for properties that are more affordable.
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