Increased Odds for Long-Term Rise in Inflation Rates

• Brief inflation hike to be expected in the wake of the pandemic
• Increased inflation rates and lower interest rates will result in negative real interest
• Negative real interest will make real estate yet more attractive
• Experts anticipate rise in NPLs in certain segments

Berlin, 26 March 2021 – The end of the corona year 2020 with its massive government aid programs in North America and Europe has caused the public debate to return to the subject of inflation. The end of the coronavirus pandemic will coincide with an initial hike in inflation. It will be little more than a catch-up effect, and will not persist. But in the long run—meaning over the next ten years—higher inflation rates than those seen in the recent past have become much more likely. The highly indebted countries need negative real interest rates to ensure their debt sustainability. Negative real interest means that the inflation rates outpace interest rates. For real estate markets, this implies: Negative real interest makes real estate even more attractive as an asset class.

These are the key takeaways of today’s online press conference headlined “Inflation Returning? What Does That Mean for Real Estate Markets?” and attended by Prof. Dr. Friedrich Heinemann, head of the research department “Corporate Taxation and Public Finance” at the ZEW Centre for European Economic Research and adjunct professor for macro-economics at the University of Heidelberg, by Prof. Dr. Steffen Sebastian, tenured chair of real estate financing at the International Real Estate Business School (IREBS), University of Regensburg, by Francesco Fedele, the CEO of BF.direkt AG, and by Torsten Hollstein, the Managing Director of CR Investment Management.

Prof. Dr. Heinemann summarised the findings: “The transition to COVID-19 herd immunity will be matched by a short-lived inflation spurt, during which we may see inflation rates of three or four percent. But this short-term effect will quickly subside after the end of the pandemic. Nevertheless, there is reason to expect lengthy phases in the decade ahead during which inflation will significantly exceed the ECB’s inflation target of two percent. There are essentially two reasons for this: For one thing, many of the effects that have long put a damper on inflation, such as the ready availability of low-wage labour in Asia, are about to expire. Secondly, the very high post-pandemic debt levels in countries like Italy will be unsustainable without long-term financial aid from the ECB. The ECB itself is increasingly becoming mired in the “fiscal dominance” trap, and no longer truly able to mount a robust response to increased inflationary pressure. Long-term interest will respond to higher inflation only to some extent, because debt relief for high-debt countries can only be accomplished through falling real interest rates.”

Prof. Dr. Steffen Sebastian added: “There is a long-term relationship between interest rates and inflation. The decisive question is how to define ‘long-term.’ The ECB is a strong market player, to be sure. But it does not represent the market as a whole. While the central bank of the eurozone may ignore the need for inflation compensation when buying up government bonds, private lenders have no such option. They need inflation compensation.”

Francesco Fedele, the CEO of BF.direkt AG, said: “Negative real interest—meaning that inflation outpaces interest rates—makes real estate even more attractive as an asset class. I’m not aware of any sign suggesting that real estate investments have lost in appeal. Even if long-term interest rates were to rise, it would not compromise the attractiveness of the asset class. And this is true regardless of the type of use.”

Torsten Hollstein, Managing Director of CR Investment Management, commented: “I do not envision a fundamental shift in the years ahead that would affect the positive factors that speak in favour of the asset class of real estate. However, rent rates in certain segments will come under pressure. We are already seeing it in the case of retail real estate, and the phenomenon is arguably conceivable for offices, too. In short: We might see some reshuffling within the asset class of real estate. But the macro trend remains positive.” And Prof. Dr. Steffen Sebastian added: “In my opinion, residential real estate will be the last segment to be affected by price fluctuations.

On the subject of non-performing loans (NPL), Hollstein added: “I’ve seen the number of NPLs rise in certain segments. But these involve mainly small and medium-sized enterprises. Their trend is primarily related to COVID-19, and unconnected to interest rates and inflation expectations.”

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