Hey guys, I think I do not understand the correlation between apartments and inflation.
In the chapter about economics, they say that if inflation is above expectations, real estate increases in value due to higher cash flows. In the section about real estate, they say that real estate has low correlation with inflation, so it is an inflation hedge. How do these two things relate each other?
Any suggestion?
If it’s an inflation hedge, wouldn’t it have a high correlation with inflation (i.e. It’s value increases when inflation increases, thereby hedging the impact of said inflation)?
It was my understanding too, but the CFA curriculum seems contradictory (in the economic section, exhibit 18, they say that inflation above expectations has a positive effect on real assets, but then in the alternative investment section they say that apartments have low correlation with inflation but real estate provide inflation hedge. Maybe the point is that not all the real assets provide inflation hedge, like apartments are not correlated with inflation while offices are correlated. But I really do not know.
Can you post the exact language from the text?
“This suggests that targeting the apartment sector of the commercial real estate market over the last decade would have yielded better results than simply diversifying across all sectors. The higher returns of apartment real estate can be partially explained by a low correlation with inflation. In addition, to the degree that inflation results in a slowdown in the real economy, the apartment sector would be negatively correlated with inflation. Thus, the office, retail, and industrial sectors, whose returns seem to include an inflation component, have been at a relative disadvantage in the 1990s.” and “Overall, direct real estate investment may be able to provide an inflation hedge to some degree”
I would suggest going with the assumption that Direct Real Estate has positive correlation with inflation and that it adds diversification within the individuals portfolio.
I would be very surprised on the exam if they ask directly about Apartments. i would expect that the question would be about Direct vs Indirect Real Estate investments in the form of Property ownership vs REITS