Key Takeaways
- The most challenging environment for CRE and other risk assets is one in which inflation is falling while real interest rates are rising.
- Even in that regime, private CRE has historically produced positive average total returns, supported by income.
- When capital appreciation is under pressure, NOI growth and balance-sheet resilience become increasingly important.
- The current environment differs from 2022 because credit remains available, but return dispersion is likely to widen across assets, markets, and managers. Avoiding underperformers that blow up track records will be as important as picking the winners.
The recent rise in Treasury yields - reflecting a combination of higher term premia and firmer inflation expectations - has unsettled markets and revived concerns about a repeat of the post-pandemic repricing in commercial real estate (CRE). A month ago, we examined the
CRE has built a reputation as an inflation hedge due to its strong and consistent record of stable income returns. That is broadly true over long horizons, but the label is incomplete. Performance depends not simply on the level of inflation or interest rates, but on their direction, the speed of change, credit availability, and the underlying health of the economy.
CRE’s inflation-hedging characteristics arise primarily through income. Contractual rent growth (often tied to inflation), periodic lease resets, and the ability to reprice space can allow cash flows to adjust as prices rise. The transmission is neither immediate nor uniform: long leases can delay rent resets, while weaker demand or heavy new supply can limit pricing power. Even so, the long-run record is favorable.
Since 1980, private CRE total returns have exceeded inflation in most periods, including many episodes of elevated price growth and interest rates. The clearest exceptions have occurred during major economic or capital-market dislocations—notably the savings and loan crisis, the Global Financial Crisis (GFC), and the post-pandemic repricing over the past several years. The first two were balance-sheet recessions in which real estate was closely tied to the underlying stress. The latest correction differed in that it focused primarily on fiscal and monetary policy shifts.
The broader lesson is that inflation and interest rates are poor stand-alone predictors of CRE performance. Their interaction—together with the pace of policy change, credit availability, and economic conditions— matters more. The asset class has historically provided meaningful inflation protection in most regimes, but that protection is least reliable when real rates are rising as inflation slows.
- Prioritize durable NOI growth. Assets with pricing power, contractual rent growth, limited new supply, and manageable capital needs should be better positioned to offset valuation pressure.
- Protect the balance sheet. Leverage, refinancing exposure, and near-term debt maturities matter more when rates are volatile, even if credit remains available.
- Expect wider dispersion. Sector, market, asset, and manager selection should drive a larger share of relative performance than in a broad-based recovery.
- Treat income as the first line of defense. Headline returns may remain muted if negative capital returns offset part of the income return, but stable cash flow can continue to provide an important cushion.
Our base case is not a repeat of the post-pandemic correction, but neither is it a return to the low-rate environment that preceded it. Income should remain resilient, while durable NOI growth without excessive balance-sheet or capital-expenditure risk is likely to distinguish the strongest assets. Many properties and markets will continue to benefit from an early-cycle environment characterized by rising rents and values. Others, however, may face a cycle that never fully materializes.
Dispersion has always existed and always will, but for much of the past three decades, the market has not needed to focus on it. In broad-based recoveries, even relative underperformers often produced attractive returns, while in downturns, even strong assets struggled to generate positive performance. The V-shaped recovery following the GFC further muted these distinctions. Today is different. For the first time since the aftermath of the S&L crisis, avoiding the losers that can derail long-term performance may be just as important as identifying the winners. Alpha is earned, not given.
Risk considerations
Investing involves risk, including possible loss of principal. Past Performance does not guarantee future return. All financial investments involve an element of risk. Therefore, the value of the investment and the income from it will vary and the initial investment amount cannot be guaranteed. Potential investors should be aware of the risks inherent to owning and investing in real estate, including value fluctuations, capital market pricing volatility, liquidity risks, leverage, credit risk, occupancy risk and legal risk. All these risks can lead to a decline in the value of the real estate, a decline in the income produced by the real estate and declines in the value or total loss in value of securities derived from investments in real estate.
Commercial real estate (CRE) investing carries several inherent risks, including those related to the economy, interest rates, market fluctuations, high upfront costs, and tenant-related issues like defaults or high turnover. Economic downturns can lead to decreased property values and increased vacancy rates, while financing costs, insurance expenses, and potential environmental or structural problems can also pose significant challenges. All these factors and risks can impact rental income and overall investment returns. Inflation and other economic cycles and conditions are difficult to predict and there Is no guarantee that any inflation mitigation/protection strategy will be successful.
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