These labor cost reductions are tangibly seen in our unemployment rate, which currently stands at 9.7 percent. Corporate performance is likely to be challenged again without real growth in the economy, because companies cannot continually cut overhead in order to achieve profits. These dynamics have placed deflationary pressures on the costs of goods and services. The question is, will this deflationary pressure be a short-term dynamic, or will it be sustained? Because the government’s presses have been working overtime printing greenbacks, the commonly accepted rule of thumb is that above-trend inflation must kick in at some point given the dramatic increase in money supply. (Money-printing rampages are almost always completely about a deep lack of spending restraint by governments.)
In an inflationary environment, there is a flight to hard assets, and commercial real estate is a quintessentially great hard asset. As inflation becomes tangible, the Fed’s response will be to tighten monetary policy by increasing interest rates.
HOW WILL COMMERCIAL REAL estate perform if inflation spikes? The answer is dependent upon how severe the inflation spike is. If higher inflation is limited to 100 to 200 basis points, and lasts for a relatively short period of time, the impact on cash flow and value should be minor. However, it could crush highly leveraged, floating-rate borrowers who are barely above
The brunt of the inflationary punch will be felt by owners who mismatched long-term leased properties with highly leveraged short-term debt, as their incomes will not increase despite rising inflation, even as their debt service soars.
During the mid-1980s, we saw a significant period of negative leverage as credit flowed and the multifamily market was going through a co-op–conversion phase.
After the savings-and-loan crisis of the early 1990s, we went through a period with very disciplined underwriting and investing and saw positive leverage throughout the balance of the decade. When easily available credit returned and the condominium-conversion craze kicked in, in the mid-2000s, we once again saw a period of negative leverage.