Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 445

The relationship between inflation and commercial property

The big picture

The Reserve Bank of Australia's (RBA) most recent Statement on Monetary Policy reiterated that although inflation has picked up, price pressures in Australia remain considerably lower than in other countries. The near-term inflation trajectory was marginally upgraded, however, it is expected to remain within the RBA’s target band across the forecast horizon. The RBA expects core inflation to continue to drift higher and reach 2.5% over 2023. It also reinforced its stance “not to increase the cash rate until actual inflation is sustainably within the 2-3% target range”. The RBA has highlighted that the trajectory of inflation will be important, “with a slow drift up in underlying inflation having different policy implications to a sharp rise”. Over recent weeks, longer-term rates have increased back to pre-pandemic levels in anticipation of major central banks looking to raise rates.

At Charter Hall, we don’t pretend to know what the future holds in this space but, on balance, we subscribe with the views of the RBA that pricing pressures that have emerged across the market have largely been transitory and appear to be stabilising.

In this article, we examine the relationship between inflation and commercial real estate.

Inflation and commercial property

There are several inflation protections built into commercial property leases, particularly long-term leases. These generally include annual fixed increases, often at a given rate above the Consumer Price Index (CPI) rate. For example, a long-term lease in an industrial property might have annual rental payment increases structured at a fixed percentage plus CPI (e.g., annual rental payment increases of 3.0% would equate to a 0.5% fixed percentage plus 2.5% being the 12-month CPI rate).

Even when not linked to inflation, typical annual rent increases are set above the long-term outlook for inflation. For example, the average fixed annual rent increase across our two unlisted direct office funds average around 3.5%. Importantly, long-term leases that are either directly linked to inflation or set above long-term inflation averages can provide protection as they extend beyond short-term volatilities in inflation.

Leases may also contain expense pass-through mechanisms. With many of our lease arrangements, particularly triple-net leases, most of the expenses and capital works are ‘passed through’ which means the tenant is responsible for these expenses and capital works – not the landlord, providing protection for commercial property owners from any rising expenses.

A further protection for commercial property relates to supply, with higher construction costs slowing new developments.

Other factors that influence inflation and commercial real estate

Real estate occupier demand: Physical market drivers and real estate demand have a large impact on real estate asset performance. Elevated market vacancies can moderate rental growth, reducing the power of the inflation link for leases. However, higher quality assets typically have lower levels of vacancy, longer lease expiry profiles and stronger pricing power. These assets provide greater income stability and more robust investor demand, providing strong through-the-cycle returns.

The way in which we use real estate can also shift over time. For example, the pandemic accelerated the growth of online retailing, having opposing impacts on industrial and retail shopping centre sectors. Over the past year, industrial and logistics sector returns reached their highest level on record, significantly outpacing inflation. This can be contrasted with shopping centre retail returns, which were challenged by pandemic-related issues and compounded by structural longer-term shifts in online retail growth.

Economic growth: During some economic downturns, real estate has shadowed the negative performances of equities and bonds. During the early 90’s and GFC, the financial recession revealed severe asset mispricing and created liquidity challenges. Both inflation and real estate returns declined through this period.

However, in an economic recovery, real estate returns and values typically grew in conjunction with the rebound in inflation. The inflationary growth that has transpired over recent quarters has resulted from the dramatic economic recovery underway. If post-recession recovery is like those in the past, then overall real estate returns should grow with inflation. The chart below illustrates the relationship between property returns and inflation; when there is growth in inflation, property returns also rebound.

CPI and Unlisted Total Sector Returns (Office, Retail and Industrial & Logistics)

Allocations to real estate

This economic recession didn’t originate from the financial sector. As such, the real estate sector didn’t face the same issues relating to liquidity and the underlying confidence in asset valuation seen during past economic crashes. The global allocations to real estate, particularly across the Asia-Pacific region, continued to increase over the past year. This generates increased investor demand for commercial real estate assets across Australia.

Inflation and commercial property

Real estate provides low correlation to other investments such as hedge funds, venture capital, private equity, private debt and other hard asset classes such as infrastructure1. Investors seek real estate for the potential benefits of reducing volatility and potential risk.

These factors have already translated into increased investor demand. Investment volumes in Australia across the industrial sector reached $18 billion over the year – well above the long-term average of $4.7 billion. Similarly, transaction volumes for the office sector climbed to $15.9 billion over the past year, the highest level since 2019.

How has commercial real estate performed in periods of elevated inflation?

The charts below show how in periods of higher inflation, annual returns of commercial real estate also tend to be high and elevated, regardless of the underlying property sector.

Commercial real estate has historically provided a solid hedge and performed well in periods where inflation increases against the backdrop of economic expansionary periods. Other external market factors can also have larger influences on investment performance, including investor demand.

Outlook

Moderate inflation poses little risk to commercial property. We focus on strategies that assist in offseting the potential negative impact of rising inflation, including a focus on long leases with fixed reviews, interest rate hedging and high quality assets.

 

Steven Bennett is Direct CEO and Sasanka Liyanage is Head of Research at Charter Hall Group, a sponsor of Firstlinks. This article is for general information purposes only and does not consider the circumstances of any person, and investors should take professional investment advice before acting.

For more articles and papers from Charter Hall, please click here.

 

1. (PERE 2022) 'Look Ahead 2022 : Five reasons real estate allocation will rise next year' Charts show quarterly returns between the periods of 1985 and 2021.
Source: MSCI, ABS, Charter Hall Research

 

RELATED ARTICLES

Howard Marks on four riskiest words: No Price Too High

The RBA deserves kudos for a job well done

This 'forgotten' inflation indicator signals better times ahead

banner

Most viewed in recent weeks

Why the $5.4 trillion wealth transfer is a generational tragedy

The intergenerational wealth transfer, largely driven by a housing boom, exacerbates economic inequality, stifles productivity, and impedes social mobility. Solutions lie in addressing the housing problem, not taxing wealth.

The 2025 Australian Federal election – implications for investors

With an election due by 17 May, we are effectively in campaign mode with the Government announcing numerous spending promises since January and the Coalition often matching them. Here's what the election means for investors.

Finding the best income-yielding assets

With fixed term deposit rates declining and bank hybrids being phased out, what are the best options for investors seeking income? This goes through the choices, and the opportunities and risks involved.

What history reveals about market corrections and crashes

The S&P 500's recent correction raises concerns about a bear market. History shows corrections are driven by high rates, unemployment, or global shocks, and that there's reason for optimism for nervous investors today. 

Howard Marks: the investing game has changed

The famed investor says the rapid switch from globalisation to trade wars is the biggest upheaval in the investing environment since World War Two. And a new world requires a different investment approach.

Welcome to Firstlinks Edition 605 with weekend update

Trump's tariffs and China's retaliatory strike have sent the Nasdaq into a bear market with the S&P 500 not far behind. What are the implications for the economy and markets, and what should investors do now? 

  • 3 April 2025

Latest Updates

Investment strategies

4 ways to take advantage of the market turmoil

Every crisis throws up opportunities. Here are ideas to capitalise on this one, including ‘overbalancing’ your portfolio in stocks, buying heavily discounted LICs, and cherry picking bombed out sectors like oil and gas.

Shares

Why the ASX needs dual-class shares

The ASX is exploring the introduction of dual class share structures for listed companies. Opposition is building to the plan but the ASX should ignore the naysayers and bring Australia into line with its global peers.

The state of women's wealth in Australia

New research shows the average Australian woman has $428,000 in net wealth, 40% less than the average man. This takes a deep dive into what the gender wealth gap looks like across different life stages.

Investing

The two most dangerous words in investing

Market extremes are where the biggest investment risks and opportunities lie. While events like this are usually only obvious in hindsight, learning to watch out for these two words can alert you to them in real time.

Shares

Investing in the backbone of the digital age

Semiconductors are used to make microchips and are essential to a vast range of technology and devices. This looks at what’s driving demand for chips, how the industry is evolving, and favoured stocks to play the theme.

Gold

Why gold’s record highs in 2025 differ from prior peaks

Gold prices hit new recent highs, driven by a stronger euro, tariff concerns, and steady ETF buying – all while the precious metal’s fundamental backdrop remains solid amid a shifting global economic landscape.

Now might be the best time to switch out of bank hybrids

In this interview, Schroders' Helen Mason discusses investing in corporate and financial credit securities, market impacts of tariffs, opportunities for cash investments, and views on tier two and hybrid bonds.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.