Do REITs Really Help Hedge Against Inflation?

Due to the current state of the country and economy, there’s a lot of buzz and talk around inflation. The naira is constantly on a row and this has created conversations around earning in dollars and other foreign currencies which the naira is slowly losing its value against. Not only this, but even the buying power of the average Nigerian is slowly reducing, the constant surge in prices of items is placing things at a constant level of very little affordability. But beyond all of the hoarding of dollars to cushion the effects of inflation, real estate investment trusts are providing a hedge against inflation. In this article, I give detailed information on how this is happening.

What is Inflation?

According  to investopedia, Inflation is the decline of purchasing power of a given currency over time. A quantitative estimate of the rate at which the decline in purchasing power occurs can be reflected in the increase of an average price level of a basket of selected goods and services in an economy over some period of time. The rise in the general level of prices, often expressed as a percentage means that a unit of currency effectively buys less than it did in prior periods.

Inflation generally affects the buying power of customers and in an inflation the same amount that in a previous period bought a truck will equate to what buys a carin a more recent period. Inflation happens for a number of reasons, the most prominent being a growth in the money supply at a rate that exceeds the rate of economic growth.

Inflation can be contrasted with deflation, which occurs when the purchasing power of money increases and prices decline.

What are REITs?

REITs short for Real Estate Investment Trusts, refers to a form of investment that allows investors to own properties without being in direct control of the building. It uses a form of a crowdfunding system where money from investors is used to purchase properties, and interest from the property is given in the form of dividends to all investors. Secured by the Stock Exchange Commission, REITs are secure and are slowly revolutionizing real estate investments.

As regulated, an REIT firm must distribute 90% of its annual taxable income to shareholders. This framework delivers an income return that is unique to real estate while also offering an investor exposure to the wider equity market.

How REITs Are Helping Individuals Hedge Against Inflation

First, REITs to a large extent have a form of power over prices. The properties purchased with investor’s money are not sold but are majorly put out as rental properties. It is because of this that the rent on such properties per time can be increased to reflect the inflation. 

These adjusted prices help to cushion the effect of inflation on investors’ returns on investments. This however does not apply to all forms of REITs, if tenants sign a long term lease, the signed contract makes it difficult to increase the rent to reflect inflation, however, upon expiration of the contract, the rent may then be adjusted.

Some vital research carried across Lagos and select places across Africa further prove this point. In his research, Odu Tenigbade with the aim of empirically establishing the inflation hedging properties (or otherwise) of commercial properties in prime locations of Lagos state,conducted a research in 2011 titled; An Analysis of Relative Inflation HedgingCapacities of Prime Commercial Properties in Lagos. The Ordinary Least Square Model as proposed by Fama and Schwert (1977) was used to regress Real Estate Rates of returns against actual, expected and unexpected inflation rates. The results show that, for prime locations around Victoria Island and Ikoyi, commercial properties provide a perverse hedge against actual inflation whereas, commercial properties within Ikeja and environs have been seen to present a complete hedge against actual inflation.Furthermore, his study proved that as attractive as commercial Real Estate Investment in prime areas in Lagos seems to be, they do not provide an all time hedge against inflation. However, this is not enough reason to totally sideline investments in commercial Real Estate. Though investment in Real Estate(especially commercial Real Estate) may not totally constitute a hedge against inflation but it is sure to minimize the risk of returns erosion due to inflation.

In all, real estate generally not only has a larger capacity to bear risks, it also serves as an hedge against inflation, but more specifically, commercial REITs more than residential REITs tend to make better hedges against inflation.

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