By Grubb Properties' Investments Team
By mid-2021, investors had grown increasingly concerned about inflation. It accelerated in July at its fastest pace in more than a decade, with the monthly Consumer Price Index (CPI) reading spiking 5.4% from a year earlier.
Prices continued to surge through year-end 2021. CPI jumped an eye-popping 7% in December 2021 compared to the same month a year earlier, and up from 6.8% in November. The December reading marked the third-straight month in which inflation exceeded 6%, the fastest rate since 1982.
With inflation at a nearly 40-year high and year-on-year inflation likely to stay elevated, private equity real estate continues to draw increased investor demand as a hedge against inflation. It has historically provided protection during high-inflation periods and generated 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).
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 5.24 million homes short of what is needed to meet demand, according to a recent report from Realtor.com. 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.
Grubb Properties is laser-focused on building essential housing through our Link Apartments℠ in both resilient markets (major U.S. cities) and high-growth markets (secondary U.S. cities). Our focus on these types of markets since 2003 has provided our investors with above-average returns while benefiting communities and creating much-needed places to live.
Our Link Apartments℠ strategy is about design, our use of a rigorous process that identifies various levers that help keep construction costs in check, and our target locations. We focus on building vibrant communities near key infrastructure and creating new methods and efficiencies that benefit residents, neighborhoods, and investors. Our in-house development and property management teams make things better for those who live, work, and invest in wherever we go.
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 or collars to mitigate interest rate risk.
Historically, we’ve procured long-term, fixed-rate, construction-to-permanent loans for development deals.
For example, our Link Apartments 4th Street in Winston Salem, NC recently procured a 42-year, HUD 221(d)4 loan with a fixed rate of 3.99%. 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.