As a general rule, real estate investments -- such as rental properties or stock-based investments like real estate investment trusts (REITs) -- tend to hold up well in inflationary environments. Property values and rental income both tend to keep up with inflation over time, and the investment vehicles that invest in real estate tend to outperform the market during inflationary periods.
In 2021, inflation reached its highest level in 40 years, and REITs as a group outperformed the S&P 500 by nearly 13 percentage points. And in the modern era, REITs tend to underperform the market when inflation is 2.5% or lower, but handily outperform when inflation is 7% or higher, as it is now.
3 types of real estate investments that can thrive with high inflation in 2022
Generally speaking, real estate tends to hold up well against inflation, as we just mentioned. But it's important to realize that there are many different subsectors of real estate, and not all have the same inflation resistance. The real estate investments that tend to perform best in inflationary environments have the following characteristics:
Short lease duration: Some types of commercial properties use long-term leases that have small annual rent increases built in, while others are shorter-duration and reset to market rates more frequently. Those in the latter category tend to perform better during inflationary periods.
Pricing power: Inflation-resistant investments typically have the ability to pass price increases along to their customers. As an example, apartment REITs are an essential type of property (people need places to live), which gives landlords the ability to raise rent along with the market. On the other hand, mall REITs might be less flexible, as rapid rent increases could cause some tenants to think twice about keeping their stores open.
Resilient demand: Shorter lease durations don't help if you can't find enough tenants to fill your properties. So, it's smart to consider properties that will remain in demand even if prices rise. Think industrial real estate -- the surge in e-commerce has created such a need for logistics real estate that industrial REITs simply can't build properties fast enough.
Just to name a few examples, here are three of my top real estate investment categories for high inflation:
- Residential rentals: This can either mean owning actual investment properties or buying residential REITs like AvalonBay Communities (AVB -2.12%) or MAA (MAA -1.05%). Residential property values and rent tend to keep up with inflation over time, and the essential nature of the properties tends to make them rather recession-resistant.
- Industrial properties: I mentioned this one a bit earlier. Although industrial tenants tend to sign long-term leases, the demand for this type of property is simply off the charts right now, giving operators excellent pricing power when leasing, renewing, or releasing. Prologis (PLD -2.42%) is the industry leader, although there are several other good choices.
- Hotel REITs: Hotels have the shortest "lease" durations of any commercial property type, as they have the ability to change their room rates on a daily basis. With a combination of high demand for travel as COVID-19 restrictions wind down and the ability to raise prices with inflation, hotel REITs like Ryman Hospitality Properties (RHP 0.47%) or Host Hotels & Resorts (HST -0.93%) could be winners.
Buy for the long term
As a final thought, it's important to approach all of these as long-term investments. Real estate tends to do quite well over time, regardless of what inflation is doing. The companies mentioned here are well-positioned to thrive in the current inflationary environment, but the short-term direction of their stock prices is anyone's guess. Buy with the long term in mind.