Journal of Real Estate Finance and Economics, 15:1, 59±76 (1997)
# 1997 Kluwer Academic Publishers
Property and In¯ation: The Hedging Characteristics of
U.K. Commercial Property, 1967±1994
Barber White Property Economics
Cambridge University and Barber White Property Economics
Harvard University and Barber White Property Economics
This paper examines the statistical similarities between U.K. commercial property capital and rental values and
the price level. Our aim is to determine whether commercial property is an in¯ation hedge and, if so, what type of
in¯ation it hedges against. To answer these questions, we use both a multivariate unobserved components model
and structural vector autoregressions. We ®nd that commercial property is an in¯ation hedge but only a weak one.
More speci®cally, we ®nd that property offers some form of partial hedge against changes in the underlying
in¯ation rate but not to either temporary or permanent changes to the price level. We also ®nd that capital values
offer a stronger hedge than rental values and that industrial and retail property account for most of this hedging
capacity. We ®nd no evidence that property responds differently to high or low in¯ation but we do ®nd capital and
rental values respond more to unexpected in¯ation than anticipated price changes.
Key Words: commercial property, in¯ation, asset allocation
A common belief in the U.K. property market is that commercial property acts as an
in¯ation hedge. Like many widely held opinions, the origins of this belief are little
understood and little work, either empirical or theoretical, has been done to properly
examine the claim. This paper begins the empirical task of assessing the links between the
behavior of various sectors of U.K. commercial property and the in¯ation rate.
A distinctive feature of our analysis is that we do not think it sensible to look at the
overall correlation between commercial property and in¯ation. Commercial property will
act as an in¯ation hedge in a portfolio if, in some states of the world, it is correlated with
in¯ation or prices or both. The key issues are these: (1) In which states of the world is
commercial property correlated with in¯ation? (2) What is the extent of this correlation?
To answer these questions, we have to move away from standard regression techniques
and use more sophisticated tools that enable us to distinguish between the various different
components of in¯ation. In this study we shall focus in particular upon the trend in the
price level and the underlying core in¯ation rate, as well as expected and unexpected
in¯ation. This emphasis on different categories of in¯ation enables us to be far more