Inflation fear: where to ride the tide? Forecasting total returns with data intelligence

21 / 02 / 23 - 4 minute read

Key takeaways

• During the last two decades economic cycles of strong growth have being accompanied by moderate inflation & vice versa. Less is known about recessionary phases with strong inflation.
• Increased construction costs & delays limit new supply whilst increasing competition for existing properties. Assets with inflation-linked rental contracts are expected to be more resilient in inflationary regimes.
• Average total returns are achieved in an economic environment with an inflation rate between 3% and 4% and 1% to 3% GDP growth. An economic recession of -2% with inflation close to 4% lead to negative total returns of ca. -2% (5% income & -7% capital growth). A stagnated economy (≈0%) does not lead total returns to decline from their long-term average as long as inflation is between 0% and 3.8%. Higher inflation levels leads to significantly falling total returns.
• Office pricing has never been more dependent on financial markets than 4 today as shown by variance share of the 10-year gov. bond yields.
• A 100-bps increase in 10 years gov. bond yields from 0% to 1% leads to an increase of 110 bps in office yields. Our model sees an increase in average European office yields from 3.5% in 2022Q3 to a peak of 5.3% in 2024Q2, i.e. 180 bps ceteris paribus.
• Looking at properties held for at least four years, the increased market value and the income already achieved act as a 'buffer' for the recent valuation declines. As a result, investment values would remain comfortably over their initial values throughout most of our simulation. Even retail, as the most vulnerable sector, would regain its initial investment value by the end of 2025

Authors

Dr. Marcelo Cajias

Georg Kläger