The commercial real estate industry faces new adversity as it navigates an economic phase marked by higher interest rates and slowing income growth, an economic condition commonly known as stagflation. While there is debate about whether the broader U.S. economy faces this condition, there is little doubt that the commercial real estate sector is already experiencing stagflation’s effects.

Given that it has been decades since the previous stagflationary environment of the 1960s and 1970s, it may be time to revisit the lessons learned from that period and look to rewrite the playbook as investment strategies for commercial real estate based on the availability of inexpensive debt may no longer be successful over the long term.

British politician Iain McCleod introduced the term “stagflation” in 1965, and it has since become a significant part of economic discourse. While this analysis focuses on the effect of stagflation in the commercial real estate industry, it’s important to note that this economic shift marks a departure from the 40-year decline of long-term interest rates, a pivotal change for both the U.S. economy and the real estate industry alike.

Since the 1980s, the yield on the 10-year Treasury has served as a significant incentive for real estate investment. Beginning in 2000, Treasuries began to steadily decline, from yielding an average of 5% to as low as 0.5% by 2020. This made access to inexpensive debt for acquiring or developing commercial property widely available and attracted investors seeking the higher rates of return available from appreciating real estate assets.

Despite brief periods of falling property income growth, lower interest rates have come to the rescue of investors by propping up asset property values.

However, the operating environment in place for the past four decades took a sharp turn following the pandemic outbreak with Treasuries climbing 400 basis points and settling into a range of between 4.4% and 4.6% as of early May 2024.

These yield levels have not been seen since October 2007, underscoring that many active finance and real estate professionals may be unaccustomed and unprepared for a market where debt is simultaneously more expensive and less accessible than in recent years.

The current rise in borrowing costs coincides with a significant slowdown in income growth across most property sectors. According to data from Nareit’s All Equity Same Store NOI Growth Index, property incomes peaked at 8.4% year-over-year in the first quarter of 2022, but have since tumbled to 3.6% in the first quarter of 2024.

This stark reduction in property income signals stagnation occurring inside commercial real estate, where sluggish income growth of 3.6% averaged across all sectors has barely outpaced the headline inflation rate of 3.4% in April 2024.

Amid these broad market trends, the impact on specific property sectors varies. While REIT-owned manufactured homes, industrial properties and healthcare facilities report hearty annual income growth averages of 8.4%, 7.8%, and 7.6%, respectively, other property sectors have struggled to keep pace with headline inflation. The apartment sector, for instance, showed a meager 2.5% annual income growth average, while property income growth averages for the office and self-storage property sectors have turned negative, each experiencing around -0.3% average income growth year-over-year.

Few market participants were active during the last stagflationary environment of the 1960s and 1970s, and the lessons learned may have long been forgotten. It’s time to rewrite the playbook and assume that yesterday’s successful investment strategies may not be tomorrow’s winners.