By guest contributor Jeremy Jiang, Analyst, Atchison Consultants
The risks facing long-term investors may be categorised into two parts: systematic risks and unsystematic risks. Unsystematic risk is a type of uncertainty which comes with a company or industry you invest in. Systematic risk generally includes uncertainties inherent to an entire market, such as interest rates, economic recession, wars and inflation.
Inflation, as a type of systematic risk, has been widely recognised as one of the principal concerns of long-term investors. However, a range of assets can be included in a portfolio which may partially protect investors.
Recently, expectations for rising inflation have emerged following sustained low interest rates and low unemployment in Australia. Property can protect investors against inflation as inflation impacts both current rents as well as property expenses. Thus, property can create a hedge against inflation.
On the one hand, inflation may push up the rental rate on new leases, but it may also reduce net rents as all expenses increase. However, if a landlord passes these expenses to a tenant as an offset, then the landlord will be protected.
Chart 1: Annual Property Income Returns and inflation (CPI?) to 31 March 2018
Source: MSCI/IPD, RBA
On the other hand, rental agreements generally have fixed annual increases, or it relates to the CPI increases. Therefore, it may create a margin for the property investor when the inflation rate rises slowly. It is another way for property investors to lower inflationary impacts.