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Inflated Commercial Values

Posted by Jerad Giottonini on May 6, 2022

The impacts of rising interest are propelling inflated commercial values. Right now, there is fear that the Federal Government is poised to impose another interest rate which are causing stocks to sell-off.

Meantime, the Bureau of Economic Analysis reported that the personal consumption expenditures price index rose 6.6% over the 12 months ending in March and up from a 6.3% annual inflation rate in February.

Mountain West says the commercial real estate industry is a good hedge for inflation but says some assets are better able to withstand price increases than others.

On the other hand, equity commercial real estate investors should be able to benefit from pricing prices. Numbers from Nareit research show that dividend increases for Real Estate Investment Trust outpaced inflation in 18 of the last 20 years.

Another problem is that developers are facing persistent pricing challenges for materials and labor.

Wes Christensen, hospitality broker, Mountain West Commercial gave one recent example which was a spike of 60 percent — in just the last year alone — for a local hotel in basic replacement and construction costs to maintain the facility.

“The shortages in materials, the shortages in skilled laborers, drive construction costs to points where some deals are no longer making sense to build because they’re getting so expensive,” said Christensen. “Lumber, for example, has gone up 3x through COVID. Which, if you could imagine what that would be on a commercial real estate property, what kind of impact that would have — it would be dramatic”.

PBMares an accounting and consulting firm says, this pricing pressure carries over to most developments. Commercial real estate tends to appreciate in value proportional to inflation.

There are several variables and compounding effects to consider, Ryan B. Paul, CPAwrote in an April 7 PBMares blog.

“Inflation as a response to strong economic growth is a good thing when it comes to CRE; inflation because of persistent unemployment and stagnant demand is not,” Paul wrote. “In the current environment, inflation, as it stands, will be good for CRE; but then again, it depends on the property type and stakeholder.”

Inflation—and its effect on CRE—differs for developers, buyers, and tenants. Paul said that developers when experiencing the rising cost of goods and higher interest rates, “are likely to pause or adjust new projects.”

He said one exception is for tenants who were able to lock in a long-term lease with guaranteed low rent increases; “they will see a similar benefit as owners of existing developed properties,” Paul wrote.

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