CAN INVESTING IN REAL ESTATE HEDGE AGAINST INFLATION?
WHAT IS INFLATION AND HOW DOES IT IMPACT ME?
The annual inflation rate in the United States is currently around 7.5%—the highest it has been since 1982. It doesn’t matter if you’re a cashier, lawyer, plumber, or retiree; if you spend U.S. dollars, inflation impacts you. Economists expect the effects of inflation, like a higher cost of goods, to continue. Luckily, an investment in real estate can ease some of the financial strain. Here’s what you need to know about inflation, how it impacts you, and how an investment in real estate can help.
Inflation is a decline in the value of money. When the rate of inflation rises, prices for goods and services go up. Therefore, a dollar buys you a little bit less with every passing day. The consumer price index, or CPI, is a standard measure of inflation. Based on the latest CPI data, prices increased 7.5% from January 2021 to January 2022. A little bit of inflation is considered healthy for the economy, but 7.5% in a single year is high.
HOW DOES INFLATION AFFECT YOUR LIFE?
- Decreased Purchasing Power
We touched on this already, but as prices rise, your dollar won’t stretch as far as it used to. That means you’ll be able to purchase fewer goods and services with a limited budget.
- Increased Borrowing Costs
In an effort to curb inflation, the Federal Reserve is expected to raise the federal funds rate. Therefore, consumers are likely to pay a higher interest rate on new mortgages, car loans, and variable-rate credit cards.
- Lower Standard of Living
Wage growth tends to lag behind price increases. According to Moody Analytics, when adjusted for inflation, average weekly earnings in January were down 3.1% from a year earlier. As such, life is becoming less affordable for everyone. Inflation can force those on a fixed income, like retirees, to make lifestyle changes and prioritize essentials.
COMBAT INFLATION BY INVESTING IN REAL ESTATE
If you store all your savings in a bank account, inflation is even more damaging. As of February 2022, the national average interest rate for a savings account is 0.06%, not nearly enough to keep up with inflation. And economists don’t expect that rate to go much higher.
One of the best ways to mitigate these effects is to find a place to invest your money other than the bank. Even though interest rates are expected to rise, they’re unlikely to get high enough to beat inflation. If you hoard cash, the value of your money will decrease every year and more rapidly in years with elevated inflation. Owning real estate does more than protect your wealth—it can actually make you money. For example, home prices rose nearly 17% from 2020 to 2021, 10% ahead of the 7% inflation that occurred in the same timeframe. Additionally, certain types of real estate investments can help you generate a stream of passive income. In the past year, property owners didn’t just avoid the erosion of purchasing power caused by inflation; they got ahead.
Whether you already own a primary residence or are still renting, now is a good time to also start thinking about an investment property. The types of investment properties you’ll buy as a solo investor generally fall into two categories: long-term rentals and short-term rentals. If you own your home, you’re already ahead. The advantages of homeownership become even more apparent in inflationary times. As inflation raises prices throughout the economy, the value of your home is likely to go up concurrently. At the same time, you’ve locked in a set mortgage payment for the next 30 years, so you’ll be immune to rising rental costs.
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INVEST IN A MULTI-FAMILY PROPERTY
One strategy used to hedge against inflation is to invest in a multi-family property. Unlike commercial properties like retail shops or restaurants, which usually have multi-year business leases, individual rental units usually renew leases every year. The more units a building has, the more frequently you’re presented with opportunities to adjust the rent. Unlike some commercial properties like retail shops or restaurants, which usually have multi-year business leases, individual rental units usually renew leases every year. The more units a building has, the more frequently you’re presented with opportunities to adjust the rent.
Additionally, multi-family properties like apartment complexes are a unique asset class in that they are always in demand (especially when housing prices go up), but also see a relatively high turnover rate at 47.5%. Plus, due to the increase in labor and material costs, there can be a limited supply of buildings or new development projects, which can create an increase in rental rates and property values. Together, these two factors equal a property that will likely not be vacant for long stretches of time and multiple opportunities to renew or start leases at market-adjusted rates.
An additional point to consider is that expense reimbursements, another lease component, is another way real estate is able to pace inflation. Leases pass some form of a property’s operating expenses down to their tenants, regardless of the type of building structure. For example, with a triple net lease property, the tenant is responsible for 100% of property-related expenses. As utility and maintenance fees rise with inflation, landlords and owners may be partially insulated from the effects on the property’s cash flow.
INVEST IN RENTAL PROPERTIES
Every year, the dollar loses a little value. And every year, landlords raise rents (or at least they should), to keep pace with or surpass inflation. For this reason, rental properties offer excellent protection from inflation. You buy the property with today’s dollars, borrow a fixed-interest rental property loan, and then raise rents even as your mortgage payment stays the same. Say you bought a median house 30 years ago for $120,000, and borrowed a $100,000 rental property loan at 5% interest. Your monthly payment would be $536.82.
At that time, imagine the property rented for $1,400 per month. You earned a reasonable cash-on-cash return, but nothing earth-shattering. But with every year that went by, you raised the rent. Today, it rents for $3,200 per month — yet you still only pay $536.82 for the mortgage payment, after 30 years, you’d have paid the loan off entirely, dropping it to $0. See how inflation favors landlords and real estate investors?
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