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

There are biased ideas that are supported by professionals in this field simply because it is a source of their income. Thus, “sellers of real estate tax exemptions”, such as Pinel or others, real estate agents, brokers and other real estate agents will assure you that real estate is a weapon against inflation. Thus, real estate would be a parade against high inflation. This is pointed out everywhere, stated in all programs, picked up by all media. What is most surprising for those who know financial asset managers who specialize in real estate is that they themselves are not convinced. And not in vain. But at the level of depositors and investors, the general public does not help, it would be true. No matter, everyone has their own opinion, here are some arguments against the people’s truth. This article is not intended to change the reader’s mind. Everyone has their own opinion.

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

In recent years, real estate prices have risen steadily and inflation has been very low. This is not something we are interested in, we would like to know if, in the presence of high inflation, real estate as a whole will grow. Quite the opposite could happen. Let’s start with income from real estate, rent. Easy, rents rise with inflation! Are you so sure?

But on paper … Real estate income is well protected from inflation

If you are a landlord, you will repeat the IRL on an annual basis, as stated in your lease. Oh, by the way, is that really so? Well no. But this is a strong argument: because rents are indexed to inflation, using the Rental Reference Index (IRL), real estate will be an excellent protection against high inflation. Rents will rise, more or less, with inflation. In this way, donor income will be saved. Theoretically, we agree. Theoretically yes, but in practice I completely disagree. For several reasons:

  • Inconsistency of IRL with real life : Annual inflation in France is now 5.6%. IRL displays 2%. Not a problem, the IRL by the calculation method has a delayed effect for several months. Therefore, it will grow in the same way as inflation. However, the discrepancy is acceptable.
  • The increase is not applied in the case of high inflation : Did you know? 30% of leases do not provide for any indexed revaluation of IRL rents. It’s a shame. So let’s talk about the remaining 70%! Is the landlord confident that his tenant will be able to pay between 5% and 6% per year for several years? Inflation-ridden incomes are world dreams that were before, but what we are experiencing now is not inflation taught in economic lectures. This inflation is created from scratch by the liquidity tsunami imposed by central banks in recent years. There is nothing to watch. Tenants cannot pay a 6% increase in rent without having the same increase in their income.
  • Rental ceilings are not overvalued by inflation : In an increasing number of municipalities (Paris, Lyon, Marseille, Montpellier, Grenoble, Lille, etc.) there are rental ceilings. These ceilings do not necessarily correspond to inflation. Therefore, even if the rent allows you to increase the rent by 5%, the landlord may still be limited by the rent ceiling.

Despite these caveats, you believe that rents are protected from inflation. How about the price of the goods? With annual inflation of 5% in 2022, real estate prices are expected to rise by 5% this year. This will be the case in some cities, but not everywhere.

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

If real estate is an asset that can prevent inflation, the price of real estate should rise along with inflation in the same proportions. True 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. The consumer price index (inflation) for the same period increased by only 32%, or 4.78 times slower.

But are real estate prices always rising sharply during periods of high inflation? Well no. In France, it has been a long time since the period of high inflation occurred in France, but between 1979 and 1984, a period of high inflation (inflation above 10%), the price per square meter in Paris increased very slightly. . Excluding inflation, the fall in prices during this period was as much as 11%, which indicates that high inflation is in no way a guarantee of real estate prices.

And what about stone paper? SCPI?

In fact, it is significantly different. SCPI is managed by professionals who mainly invest in property leased from companies. Revaluation of rent 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 reversal of the real estate market, the loss of stock value can be terrible. Again, there is no direct link to inflation. The fall in the value of shares in 1994-1998 still marks the mood. The real estate market is developing slowly and has been watching its upward or downward trends for decades.

Historical changes in the price of SCPI shares

So, in the end?

Real estate is illiquid investments that only partially allow, under certain favorable conditions, local market conditions for real estate prices and proper rent management with rising rents, to limit the impact of inflation. But real estate does not seem to be a weapon against high inflation, it is by no means an inflation bond! In the event of a decline in the real estate market, particularly after rising interest rates, with cumulative inflation, it may even be an asset that is a source of large financial losses. Never forget that real estate is an investment that risks losing capital. It doesn’t really make sense to invest in real estate under the pretext of protection against inflation.