Inflation-Proof Your Portfolio: The Role of NNN Assets

Rising inflation shines spotlights on NNN assets as valuable inflation hedge

Consumers that are paying more for everything from a gallon of gas to groceries are stoking concerns about rising inflation. As investors, we hear a lot about the impact of inflation on investing strategies, but what does it mean exactly?

First of all, inflation generally refers to the upward price movement of goods and services in the economy. Data clearly shows a pop in inflation over the past year. The Bureau of Labor Statistics is reporting that the consumer price index (CPI) grew at an annual rate of 6.9% in 2022 – the biggest increase seen since 1990. Ultimately, consumers are paying more out of pocket. To put that into context, we can use a CPI Inflation Calculator to show how purchasing power changes over time. For example, someone who had $1 million to spend in 1990 would need $2.14 million today to buy the equivalent amount of goods.

For investors, inflation is important as it serves as a benchmark for returns needed to maintain their standard of living. As an example, you could buy a 5-year bond that generates a 3% return. If inflation hovers at 3%, your investment holds its value. However, factor in inflation at a level of 5.4%, and the value of that investment erodes. You are actually losing 2.4% in purchasing power. Rising interest rate environments highlight the advantages of investments such as commercial real estate that can rise along with inflation, thus providing a natural hedge against inflation.

A hedge against inflation is one of the many attractive benefits of commercial real estate and NNN assets. The premise is simple. A property owner has the ability to raise the rents they charge to account for rising inflation. Higher rents should correlate to higher net income for a property, which in turn drives higher values and property appreciation.

There are a variety of different ways to structure rent increases. In many cases, those rent increases or “rent steps” are negotiated as a standard part of any lease agreement. Rent increases may be added every year, three years, or five years. In fact, rents may rise even when inflation is low. In addition, when a tenant renews a lease or a new tenant moves into a property, the landlord has the opportunity to “reset” or raise rents to reflect current market levels. Property owners also can work with their broker to build inflationary measures into lease structures with methods that include:

• CPI Indexation: Contractually tethering rent increases to upward movements in the CPI

• Periodic rent reviews: These reviews are built into leases and are particularly important with longer-term leases, and/or when few or only one tenant occupies the property

Commercial real estate as an inflation hedge does have its naysayers. The caveat is that appreciation and rent increases are dependent on the quality of the property and location. High quality properties and desirable locations are in a better position to maintain and increase market rents, whereas poorly maintained properties or assets in weak locations may struggle to hold values and rent levels.

Case in point is a single tenant net leased IHOP property in Santa Ana, California (click here for more info). This property has an absolute NNN lease with zero landlord responsibilities. IHOP has a successful operating history at this location since 2002, has ~6 years remaining on its lease; and has a 10% rent increase scheduled to go into effect in a year. IHOP also has three 5-year renewal options – each of which will include a 10% rent increase. The property is an outparcel of the Home Depot shopping center at a busy signalized intersection in a strong trade area. There are more than 277,400 residents and over 18,000 businesses employing over 195,200+ employees within a 3-mile trade area.

Given that this IHOP is located at a vibrant Home Depot-anchored shopping center, it’s instantly a magnet for investors. Tenants will always want to be around other strong tenants and shopping hubs. Likewise, if a property is in a growing area, the demand will continue to rise, and property will appreciate. However, raising rents and creating that valuable hedge against inflation is not automatic or even a “sure thing." That is why it is important for investors to partner with a seasoned, experienced real estate broker who can offer guidance on properties and locations that are positioned for success.

If you are interested in learning more about triple net lease assets so that you can enjoy passive rental income and enjoy your freedom, please contact Andrew Vu at 415-539-1120 for a free, no-obligation NNN consultation.