Worried about inflation? Essential Housing as a Hedge
By Mike Ritter, Senior Associate, Investments
Inflation in the last several months has accelerated at its fastest pace in more than a decade. The Consumer-Price Index spiked 5.4% in July from a year earlier, its steepest climb in 13 years.
U.S. private equity real estate historically has provided protection during high-inflation periods, with respectable returns in low-inflation environments.
Furthermore, U.S. private real estate has had less volatile returns over time and better returns given the risk profile of other equity investments. For example, annualized over the past 10 years, U.S. private real estate (NCREIF) has a Sharpe Ratio of 3.44 compared to 0.73 for the S&P 500 (data as of March 31, 2021).
Why Essential Housing?
Multifamily housing, compared with other commercial real estate asset classes, historically has been an effective hedge against inflation. Lease terms are generally shorter and more favorable, which gives investors the opportunity to reprice rents as prices increase. But when inflation rises, so too does the cost of living, pushing housing further out of reach for many hard-working citizens.
The U.S. housing market is 3.8 million single-family homes short of what is needed to meet the country’s demand, according to a new analysis by Freddie Mac. Much of this shortage lives in essential housing, which fills the critical “missing middle” gap between affordable, government-funded housing and luxury inventory. At Grubb Properties, we believe this is one of the most resilient assets classes, and it is where we focus our strategy.
Virtually no other multifamily product is being developed in the urban geographies we target at the price segment that we offer. That means we can offer a demographic-driven strategy with a long runway, limited competition, and with an integrated management approach. Over the past seven years, this strategy has resulted in same-apartment NOI growth 75% greater than the NAREIT index.
How Grubb Properties Does Essential Housing:
For real estate investors, rising inflation can have a negative impact on returns. To mitigate the risks of inflation, we employ a prudent strategy to debt financing through longer-term maturities and hedge instruments. Although we pay a premium to get long-term debt, we believe it’s often worth it given that it reduces refinancing risk.
At our stabilized properties, we often look for maturations longer than ten years, which protects against having to tap the capital markets during unfavorable conditions. In adhering to this approach, we’ve achieved top quartile returns despite often paying significant prepayment penalties and provided insurance against the ever-looming Black Swan event. And while we usually target fixed-rate financing, we sometimes employ variable-rate loans, often purchasing interest-rate caps for additional protection.
Historically, we’ve procured long-term, fixed-rate, construction-to-permanent loans for development deals.
Recently we procured a 20-year fixed-rate loan from an insurance company and a HUD 221(d)4 loan with a fixed rate of less than 4.0% through 2061. Such HUD loans have several advantages; they are assumable, able to be prepaid, and do not have any affordability restrictions. And if rates decline, HUD offers an attractive refinancing program for existing loans. Although these loans take more time and effort to secure, we find the predictability and security for the investment worth it. In fact, we’ve found that long-term debt like the HUD 221(d)4 loans is often viewed as an asset when we sell a property since buyers have paid us a premium to assume that favorable debt.
To learn more about the methods we use to mitigate inflation, please reach out to us at email@example.com.