Germany’s inflation rate has been on the rise lately, reaching 2.5 per cent in May 2021. It is the highest level registered since 2011. Several factors come to mind that drove the inflation up to this high-water mark, among them the growth of the global economy, the accommodative monetary policy chose to address the ramifications of the coronavirus pandemic and, above all, the risen energy costs in the wake of the carbon tax hike. Experts believe that the return to the regular value-added tax rate, after a temporary cut last year, will fuel further growth in inflation during the second half of 2021. For what it’s worth, Germany’s gross domestic product rebounded with a surprisingly swift quarter-on-quarter growth of +2.5 per cent in Q2 2021 (previous quarter: -1.8 per cent). However, the German economy continues to struggle with massive aftershocks prompted by consumer reticence, stalled industries and surging commodity prices, while the outlook remains bleak against the background of spreading virus mutations.
Worries Stoked by ECB Policy
Meanwhile, the European Central Bank (ECB) has maintained its policy of extreme monetary easing and its massive bond purchases. Yet on 8 July 2021, it announced its intention to abandon its existing inflation goal for the Eurozone of “below, but close to, two per cent” and to aim for exactly two per cent in the medium term. It added that the new inflation target is to be understood in a “symmetric” sense: Under the new approach, the target itself no longer implies a cap. Temporarily undercutting or exceeding the threshold of two per cent, while undesirable, is deliberately tolerated. By how far a margin and over what periods of time remains unclear. The ECB vindicates the move by arguing that it affords more freedom of action, whereas critics find fault with the arbitrary nature of this benchmark compared to the binding limit it replaces.
Eyebrows were also raised by the announcement that the calculation of the inflations rate would from now on consider the costs of owner-occupying your home or condominium, too, in addition to rental costs. “To be sure, it is principally a good idea to have the calculation of the inflation rate map reality more closely,” said Rainer Schorr, Managing Director of PRS Family Trust GmbH, “but this will further spur the visibly growing inflation fears by backing them with official figures. The statement by the Federal Ministry of Economic Affairs that there is currently no evidence for a wage-price spiral does nothing to change the fact.”
Bricks and Mortar as Inflation Safeguard
Will “bricks and mortar,” meaning real estate, actually protect you from the effects of inflation? “Yes, it will, assuming certain conditions are met” – would be the short answer to the question. Of course, real property is not in and of itself an inflation safeguard. The performance of real estate, and thus its ability to offset inflation, depends on a wide range of variables. As with any other capital investment, everything hinges on the prudence of the investment decision.
Risk Management of Institutional Real Estate Investors
“The behaviour of professional institutional investors in this context is highly instructive,” said Rainer Schorr. “Their real estate portfolios consist to 83 per cent of properties in premium locations, occupied by blue-chip tenants.” Just 11 per cent show a medium and 6 per cent a high risk-return profile. This is one of the findings of the Investment Intentions Survey 2021, a survey conducted among institutional investors. Asked about their reasons for investing in real estate funds, the most common responses pointed to professional property management and the diversification of the investment assets. Interestingly, inflation protection ranked close to the bottom among the replies to this question. By converse argument, you could say: An unfavourable location and a dubious tenant base, as well as the management costs and risks and the cluster risks within the investment portfolio, constitute the greatest risk factors for real estate investments. Only when these threats have been deflected or defused does inflation protection begin to make a difference.
Real Estate Investments for Private Investors
This applies regardless of scale. Private or small-scale investors who ignore the aforesaid risks may, at worst, buy into a financial disaster rather than acquiring an inflation safeguard, because the forced sale of a worthless run-down property at an inflated price in an obviously unfavourable market cycle will leave nothing but a huge pile of debt. A positive counter-example would be someone who invests part of his fortune in an owner-occupied or professionally let and managed property in a good state of repair and in a sound location, or who alternatively subscribes shares in high-end property funds. This latter option is a great way to benefit from the income of an entire portfolio of professionally managed real estate even when investing small amounts, rather than sinking a major portion of your investment capital into one-sided property investment.
“Professional property management means to keep sight of a property’s entire value chain when making decisions,” said Rainer Schorr. Efficiently planning, building, letting or selling, managing, upgrading, raising the rent to match the market level and cultivating a cleverly mixed tenant base – these are standard instruments from a professional property manager’s toolbox. More advanced wealth-building strategies include, for example, an exit strategy from the start, a comprehensive site analysis that takes account of a catchment area, purchasing power, infrastructure, medium- to long-term development plans and performance outlook, and covers everything from land development potential and the zoning of land for development to the anticipation of local economic trends. Such a strategy will let you buy in at a reasonable price at the right time. Again, it is safe to say: The approaches taken by professional market operators can serve as guidance for private homebuilders and small-scale investors.
If you have done your homework as a property investor, you get the inflation protection thrown in more or less for free. Worth noting is that in the inflation context, the owner-occupied home outperforms the buy-to-let property. The nominal value of the home will go up while the costs remain manageable. This contrasts with the let property, whose rent revenues will be eaten up by inflation even though its nominal value will rise as well. Inflation losses will have to be offset through rent increases, exposing you to the risk of tenant churn or vacancies. In periods of rampant inflation, there is moreover a good chance that the government imposes caps on rent increases because tenants tend to get more protection from the lawmakers than property owners. After all, ownership is an obligation under Germany’s constitution.