Historically, multifamily properties have been regarded as a reliable inflation hedge due to their ability to adjust rental rates in response to rising costs. During periods of inflation, landlords can increase rents to keep pace with the general rise in prices, ensuring that their income stream maintains its purchasing power. Additionally, the high demand for rental housing, driven by factors such as population growth and shifting demographic trends, tends to remain stable or even increase during inflationary periods. This consistent demand supports occupancy rates and allows for regular rent adjustments. The combination of adjustable rental income and steady demand makes multifamily properties a resilient asset class that can effectively protect investors against the erosive effects of inflation.
However, despite climbing rents, landlords have struggled to increase their net operating income due to rapid cost inflation, particularly in materials and insurance. According to Fannie Mae, Yardi observed a 31% increase in insurance premiums, and RealPage reported a 32% increase. The National Association of Home Builders has highlighted the rapid growth in material costs driven by increased demand and exacerbated by geopolitical tensions and supply chain disruptions, which have persisted through 2024.1
The National Association of Home Builders shows the rapid growth in material costs due to an increase in demand and amplified by restriction in supply due to geo-political tension and disruption of supply chains, which has continued through 2024.2
When cost inflation outpaces rental growth, landlords relying on rental income from their real estate may face severe economic challenges. Net operating income from multifamily properties is struggling to keep up with inflation, as evidenced by the slowing rental growth captured by Apartments.com.3 Apartments.com captures below the slowing rental growth.4
NNN properties are commercial real estate assets leased to tenants responsible for property taxes, insurance, and maintenance costs. This lease structure reduces the landlord’s management responsibilities and ensures a steady flow of income. NNN properties are typically leased to well-established, creditworthy tenants such as national retailers, fast-food chains, and healthcare providers, offering long-term leases that can span 10 to 25 years or more.
One of the key features of NNN leases is the inclusion of rent escalations, which can be tied to inflation indices or set as fixed annual increases. These adjustments help the rental income keep pace with or exceed inflation, maintaining the investor’s purchasing power. This predictable income stream provides a reliable buffer against the erosive effects of inflation, making NNN properties a stable investment.
NNN properties are often leased to large, financially stable corporations that are less likely to default on payments during economic downturns. The long-term nature of these leases provides a consistent flow of rental income over extended periods, which is crucial during inflationary times. Reliable tenants contribute to the stability and predictability of the income stream, providing a safeguard against inflation.
In an NNN lease, the tenant is responsible for paying property taxes, insurance, and maintenance costs. As these expenses rise with inflation, the burden does not fall on the property owner but on the tenant. This arrangement protects the investor’s net income from inflationary pressures, ensuring that increasing operational costs do not erode returns.
While NNN properties are depreciating assets due to the wear and tear of the physical structure, the underlying land value can appreciate over time, especially in prime locations. This appreciation in land value can offset some of the depreciation of the building, preserving the overall value of the investment. In markets with strong economic fundamentals, the land component can act as a hedge against inflation.
NNN properties come with their own unique risks, and investors should consult with their CPA, tax, and real estate advisors to ensure that this type of asset is suitable for their situation. NNN and net lease assets are not suitable for everyone. However, for the right investors, NNN and net lease properties may be an effective strategy to mitigate inflation risk and maintain predictable income. By carefully selecting properties, evaluating tenants and lease terms, and diversifying investments, investors can leverage the inflation-hedging benefits of NNN properties while managing the associated risks.
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1 https://www.fanniemae.com/media/51396/display#:~:text=By%20December%202022%2C%20just%20four,Page%203
2 https://www.nahb.org/advocacy/top-priorities/material-costs
3 https://www.globest.com/2024/06/26/multifamily-challenges-include-rising-costs-slowing-noi/
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