Forecasting total returns under macroeconomic stress – a bivariate semiparametric approach

Inflation is corrosive to real estate values. The performance resilience of real estate is directly linked to the ability to react to expected and non-expected changes in inflation. The degree of protection of the income component to higher-than-expected inflation is directly related to the ability of leases to consider CPI-escalation clauses. From the capital return perspective, assets with inflation-linked rental contracts are expected to provide higher protection due to more resilient real capital values. In order to assess the impact of inflation and interest rate hikes on the performance components of institutional real estate we merge MSCI performance data with macroeconomic fundamentals from Oxford Economics and estimate a semiparametric dynamic model. The results confirm that in an environment with +8% inflation, an economic growth of at least 2.5% is required in order for the income returns not to fall below long-term averages, whilst capital returns are not substantially affected in a recession with 4% inflation.