Inflation touches everything in commercial real estate. Property values, construction costs, operating expenses, rental rates, and of course, financing costs.
Let’s talk about where inflation stands in early 2026, how it’s affecting commercial and agricultural mortgages, and what borrowers should be thinking about.
The Inflation Picture
Canadian inflation has come down significantly from the peaks of 2022-2023, but it hasn’t returned fully to the Bank of Canada’s 2% target.
We’re running around 2.4% to 2.7% on headline CPI depending on the month. Core inflation measures, which strip out volatile food and energy prices, are in a similar range.
That’s much better than the 6% to 8% inflation we saw at the peak. But it’s still above where the central bank wants it, and more importantly, it’s proving sticky at this level.
What’s driving the persistence? Several factors.
Wage growth continues to run around 4% to 5% annually. When workers are getting raises in that range, businesses pass those costs through to consumers. That creates ongoing inflation pressure.
Services inflation, particularly in housing-related services, remains elevated. Shelter costs, which include both rent and homeownership costs, are a huge component of CPI and they’re not coming down quickly.
Some goods prices have moderated, but they haven’t reversed back to pre-pandemic levels. We’ve essentially seen a step-change upward in the price level for many items.
How Inflation Affects Property Values
Inflation has complex effects on commercial and agricultural property values.
In theory, real estate should be an inflation hedge. Properties generate rental income that can increase with inflation. Land and buildings are tangible assets that should maintain real value over time.
In practice, it’s more complicated.
Rising inflation tends to push interest rates higher, which increases cap rates and reduces property values. The math is straightforward: if a property generates $100,000 in net operating income, and cap rates go from 5% to 6%, the property value drops from $2 million to $1.67 million.
That’s what we saw in 2022-2023. Inflation surged, interest rates rose to combat it, cap rates expanded, and commercial property values fell.
But over longer time periods, properties can adjust. Landlords raise rents to keep pace with inflation. Operating cost increases get passed through to tenants. Property values eventually reflect the new price level.
Where we are now in early 2026 is in that adjustment phase. Properties have repriced lower from peak values, but they’re generating higher nominal income than a few years ago. The question is whether income growth can catch up to the interest rate increases that have already happened.
Financing Costs in an Inflationary Environment
Here’s the direct connection between inflation and your mortgage.
Lenders price loans based on their expected return after accounting for inflation. If they expect 2% inflation, they might be happy with a 5% nominal interest rate because that’s a 3% real return. If they expect 4% inflation, they need a 7% nominal rate to achieve the same real return.
This is why mortgage rates were so low during the 2015-2019 period when inflation was consistently below 2%. It’s also why rates spiked in 2022-2023 when inflation surged.
Right now, with inflation running around 2.5%, lenders are pricing in some inflation expectation but not dramatic future increases. That’s why five-year fixed rates are in the 5% to 6% range. That’s roughly 2.5% to 3.5% real return for lenders, which is reasonable but not excessive.
If inflation were to accelerate again, say back above 4%, you’d see mortgage rates move up significantly. If inflation were to fall to 1.5%, you’d see rates come down.
The Operating Cost Challenge
Inflation affects not just financing costs but also property operating expenses.
Property taxes tend to rise with inflation, sometimes even faster as municipalities face budget pressures. Utilities, insurance, maintenance, and property management all cost more in an inflationary environment.
For commercial landlords, the ability to pass these costs through to tenants depends on lease structures. Triple net leases pass through most operating costs to tenants. Gross leases put more burden on landlords.
If your leases don’t have inflation adjustments built in, rising operating costs squeeze your net operating income. That affects both your cash flow and your property value.
For agricultural borrowers, input cost inflation has been significant. Fertilizer, fuel, equipment, and land costs have all increased. Even with commodity prices that are adequate, margin per acre has compressed because costs have risen so much.
Lenders are very aware of this dynamic. When they analyze a farm operation or commercial property, they’re looking at whether the business can maintain margins in an inflationary environment.
Rental Rate Growth
The flip side of cost inflation is revenue growth through rent increases.
In a functioning market, landlords can raise rents over time to keep pace with inflation. That protects real returns and supports property values.
The ability to do this varies by property type and market conditions.
Multi-family residential landlords in most Canadian markets have been able to raise rents significantly. Strong demand, limited supply, and inflation have combined to drive rent growth of 4% to 8% annually in many cities over the past few years.
Industrial landlords have also had pricing power. Tight vacancy and strong demand have allowed rent increases that more than keep pace with inflation.
Office and retail landlords have less pricing power in many markets. Vacancy is elevated in some sectors, and tenants have negotiating leverage. Rent growth has been muted or even negative in these property types.
For agricultural land, rent increases are more gradual and tied to commodity economics rather than inflation directly. Farmland rental rates have increased over the past five years, but not as dramatically as some cost inputs.
Fixed vs. Variable in an Inflationary World
The inflation outlook affects how you should think about fixed versus variable rate mortgages.
If you expect inflation to remain stable or decline, variable rate mortgages become more attractive. You benefit as central banks cut rates in response to lower inflation.
If you expect inflation to stay elevated or increase, fixed rate mortgages provide protection. You lock in a rate that might look high today but reasonable if inflation pushes rates higher in the future.
The current consensus is that inflation will continue to moderate gradually. That argues for variable rates potentially outperforming fixed rates over the next few years.
But there’s risk in that view. If inflation proves more persistent than expected, variable rates could stay high or even increase.
My thinking is that the uncertainty around inflation makes fixed rates attractive for borrowers who value certainty. You’re not paying a huge premium for fixed rates right now, and you eliminate the risk of higher payments if inflation stays stubborn.
Real Returns vs. Nominal Returns
Here’s a concept that matters but often gets missed: the difference between real and nominal returns.
If you own a property that appreciates 4% per year but inflation is 3%, your real return is only 1%. Nominal appreciation feels good, but what matters is whether you’re gaining purchasing power.
Similarly, if you have a mortgage at 5.5% and inflation is 2.5%, your real interest cost is about 3%. That’s the actual cost in today’s dollars.
In high inflation environments, fixed rate debt becomes more attractive because you’re paying back the loan with dollars that are worth less over time. Inflation erodes the real value of your debt.
In low inflation environments, debt is less advantageous because the dollars you’re paying back hold their value better.
Right now, with moderate inflation, the benefit of debt from an inflation perspective is present but not dramatic. You’re getting some real cost reduction from inflation but not the massive benefit that borrowers experienced in the high inflation period of the 1970s and early 1980s.
Construction and Development Costs
Inflation has hit construction costs particularly hard, which affects development financing and property values.
Building costs have increased 25% to 35% since 2019 in most Canadian markets. Labor shortages, material costs, regulatory compliance, and general inflation have all contributed.
This has several implications.
New development requires higher revenues to justify the cost. Either rents need to be higher, or sales prices need to be higher, or the project doesn’t pencil out.
Existing buildings become relatively more valuable because replacement cost has increased so much. The gap between what it costs to build new and what existing buildings trade for affects cap rates and valuations.
For borrowers seeking development financing, lenders are much more conservative on construction loans because of cost uncertainty. Budget overruns are common, and lenders don’t want to be stuck funding cost increases that weren’t anticipated.
Income Property Analysis
When lenders analyze income properties in an inflationary environment, they focus on several key factors.
Rent growth potential. Can the property increase rents to keep pace with inflation? Properties with below-market rents or expiring leases have upside. Properties already at market rents need to demonstrate market rent growth.
Lease terms. Long-term leases with fixed rents are less attractive in inflation because the landlord can’t adjust pricing. Shorter leases or leases with inflation adjustments are preferred.
Expense control. Can the landlord manage operating cost increases? Are there efficiency opportunities? Can costs be passed through to tenants?
Debt service coverage. Is there enough margin between net operating income and debt service to handle inflation in operating costs without rent growth?
Lenders want to see that a property can maintain its debt service coverage even if expenses increase faster than expected.
Agricultural Considerations
For farm operations, inflation dynamics are slightly different.
Input costs have increased significantly: fertilizer, fuel, seed, chemicals, equipment. These costs are largely driven by global commodity markets and aren’t necessarily tied to Canadian CPI.
Farm revenue is driven by commodity prices, which are also global markets. There’s not a direct correlation between Canadian inflation and grain prices or livestock prices.
What matters for farm lenders is the relationship between output prices and input costs. If both are rising, margins can be maintained. If input costs rise faster than output prices, margins get squeezed.
Right now, we’re in a period where input cost inflation has moderated from the peaks of 2022-2023, but costs are still elevated. Commodity prices are adequate but not spectacular. Margins are workable but not generous.
Lenders analyzing farm operations focus on whether the farm can generate sufficient cash flow to service debt with current cost structures. Historical financials matter, but understanding current economics is critical.
Strategies for Borrowers
Given the inflation environment, here are some strategies to consider.
Lock in fixed rate financing if you can get reasonable terms. The uncertainty around inflation makes rate certainty valuable. If you can get a fixed rate within 50 to 75 basis points of variable rates, consider taking it.
Focus on properties or operations with pricing power. If you can increase your revenues to keep pace with inflation, whether through rent increases or commodity sales, you protect your real returns and maintain debt service ability.
Be conservative on leverage. Higher inflation typically means higher interest rate volatility. Having strong debt service coverage and lower loan-to-value ratios gives you cushion to handle unexpected cost increases.
Include inflation assumptions in your projections. When you’re analyzing an acquisition or development, don’t assume costs stay flat. Build in realistic inflation assumptions for expenses, and make sure your revenue projections account for how you’ll maintain margins.
Consider inflation-protected lease structures. If you’re a commercial landlord, negotiate lease terms that allow for inflation adjustments. CPI escalators, periodic market rent resets, or expense pass-throughs all help.
The Outlook
Where is inflation headed over the next few years?
The Bank of Canada expects inflation to continue moderating toward the 2% target through 2026 and into 2027. That’s the base case.
But there are risks in both directions. Inflation could stay stubborn around 2.5% to 3.0% if wage growth remains elevated and housing costs don’t come down. Or inflation could drop below 2% if the economy weakens and demand softens.
For borrowers, the prudent approach is to plan for inflation to remain in the 2% to 3% range and to ensure your financing structure can handle that environment. If inflation drops meaningfully below that, great, you have more cushion. If it stays higher, you’re not caught unprepared.
Professional Guidance Matters
Navigating financing decisions in an uncertain inflation environment requires understanding both macroeconomic trends and specific property or farm economics.
At Creek Road Financial Inc., we help borrowers think through these dynamics and structure financing that makes sense for their situation. We work with lenders who understand how inflation affects different property types and agricultural operations.
Whether you’re acquiring property, refinancing existing debt, or planning for growth, we can help you understand your options and secure terms that position you well for whatever inflation environment emerges.
Let’s discuss your financing needs and how to structure debt that works in the current economic climate.