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Inflation and Real Assets

Real assets may perform well in periods of higher inflation, especially when accompanied by strong economic growth as demand rises for real estate space and economic infrastructure.

What to expect

Global real assets investors have been increasingly focused on inflation, as surging demand and stockpiling alongside supply constraints is driving up price pressures. In this paper, we discuss our views on inflation, whether it is transitory and where it will go. More importantly, we will discuss the reasons why real assets may perform well in periods of higher inflation, and tools and strategies real assets investors should deploy in a higher inflationary environment.

Key themes

01

A powerful restart

In the U.S., core inflation spiked during the first half of 2021, driven by supply constraints alongside surging demand and stockpiling. Our view is that core inflation has peaked, but where it will settle after this transitionary period is unclear.

02

Keeping up with inflation

Real estate and infrastructure outperformed other asset classes during previous inflationary periods. This is because leases and revenue streams are linked to inflation, and at the same time there is often some form of expense pass through. Past performance is not a reliable indicator of current or future results.

03

Strategies during higher inflationary regimes

Inflation sensitivity will vary across real estate and infrastructure sectors, and for equity and debt investors. Assets with shorter-term leases or take-or-pay contracts tend to capture the upside in inflation well, and long-term leases and contracts (i.e. power purchase agreements) linked to inflation can provide some form of risk mitigation.

Higher, not runaway

Economic reopening, combined with record levels of fiscal and monetary stimulus, higher production costs and realignment of global supply chains is driving a robust outlook for economic growth and the highest inflation expectations in almost a decade. Inflation should build steadily over the medium term, well above the Fed’s 2% target. Supply constraints and surging demand will likely keep short-term inflation more volatile. The BlackRock Investment Institute (BII) sees inflation near 3% in five years, above current breakeven rates, but well below 1970s levels of hyperinflation.

Inflation-linked

Returns from both real estate and infrastructure have positive correlation to inflation, especially when it is combined with high economic growth. Real assets can capture inflation through greater income growth due to higher rent growth, occupancy, and increased demand for the underlying good such as electricity. The risk of accelerated expense growth is primarily mitigated through (1) contractual adjustments in leases or contracts, (2) expense pass-throughs, (3) higher replacement costs, and (4) beneficial leverage.

Quotation start

The risk of accelerated expense growth is primarily mitigated through (1) contractual adjustments in leases or contracts, (2) expense pass-throughs, (3) higher replacement costs, and (4) beneficial leverage.

Quotation end

Real assets have historically outperformed in inflationary environments

Real assets outperform traditional asset classes during high inflation environments.

Real assets performance against growth and inflation

Source: Bloomberg, Barclays (Investment grade: US Agg Bond; Gov’t bonds: US Gov’t Agg TR), NCREIF (U.S. Real Estate: NPI), MSCI (Global Real Estate); EDHEC (Infrastructure: All equity) and S&P (Stocks: S&P 500); as of December 31, 2020 (annual data since 2001). The figures shown relate to past performance. Past performance is not a reliable indicator of current or future results. You cannot invest directly in an unmanaged index. High growth periods are when U.S. GDP > 2.5% and high inflation periods are when U.S. CPI > 2.5%.

Focus on what you can control

Inflation, interest rates and rents or rates are determined by the market and cannot be controlled by investors. Thus, it is best to focus on what one can control when structuring deals and building portfolios.

  • Term & structure: Shorter lease terms would allow rents to mark-to-market more often, thus benefitting the investor. While longer-term, take-or-pay contracts for midstream investments could also offer some degree of explicit inflation management as revenues rise with higher demand. Leases or contracts with annual bumps in-line with inflation and expense pass throughs are preferred.
  • Asset characteristics: Assets in low supply markets will likely benefit from a high growth and inflationary environment. What is more important than the topic of inflation are the accelerating trends of e-commerce, migration to less dense areas, digitization and decarbonization driving the different real assets sectors.
  • Debt term & structure: Levered assets with longer-term fixed rate debt would benefit in an inflationary environment, as debt gets paid down with inflated dollars over time.
Download the full inflation and real assets paper
Read why real assets may perform well in periods of higher inflation and which strategies real assets investors should deploy in a higher inflationary environment.
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Steven Cornet
Head of Americas, Real Assets Research
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Yasmine Kamaruddin
Real Assets Research
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