Why Investors Seek Real Estate During Periods of Inflation
April 12, 2022
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Inflation isn't something anyone was prepared for at the levels we're experiencing. Consumer prices have been hit hard, but investors are hit the hardest. If you don't know where to invest your money, you could have a much lower gain than you anticipated when you first invested.
This is why investors seek real estate during periods of inflation. It keeps the pace with inflation, you can raise rents when necessary, mortgage rates continue to be affordable, and property income can provide a steady cash flow.
What Is Inflation
You've likely heard a lot about inflation lately, but do you know what it is and how it affects you?
Inflation is an increase in consumer prices for goods and services over a period of time, usually measured annually. Another way to think about inflationary periods is a drop in the value of a dollar. Your dollar will buy you less than it would during periods of lower inflation.
You'll likely experience inflation at the gas pump, grocery store, and other retail stores, as well as restaurants and other entertainment venues. In short, it costs more for the daily cost of living.
Many things can cause an inflationary period, but here are the most common reasons:
- A surplus of money in the economy (such as occurred with stimulus payments)
- Excessive access to credit which spurs more consumer spending
- High demand for products and services, and companies can't keep up
- Supply chain issues that cause a shortage or increase the cost of materials
Managing inflation is often a government issue, requiring the Federal Reserve to adjust the interest rates to reduce inflation. For example, if inflationary periods get out of control, the Federal Reserve may increase rates to slow things down and vice versa.
While you can rely on the government to reduce inflationary risk, there is only so much they can do. So instead, you can focus on yourself and ways you can hedge against inflation with your investments.
There are many ways to hedge against inflation, but the most common are as follows:
- Diversify your portfolio - Diversifying your portfolio from the standard stock market investments can help reduce a total loss should a crisis occur. While you could diversify by investing in different types of stocks, you could also add real estate investments to your portfolio to diversify.
- Keep cash - Sometimes, keeping a portion of your portfolio in cash can hedge against inflation. While you don't want a large percentage of your portfolio in cash because there's virtually no return on your investment, keeping some funds liquid can be important.
- Practice arbitrage - Buying an asset for a low price (undervalued) and selling it immediately for a higher value is arbitrage and can be a great way to hedge against inflation.
There's no right or wrong way to protect yourself from inflation. What is most important is that you do it. Dealing with an inflationary environment can be risky to your investments, but you reduce the risk of your dollar losing value if you know how to offset it.
Hard Assets vs Soft Assets
Investing in hard and soft assets can be a great way to diversify your portfolio, but focusing on hard assets, such as real estate investing, is one of the best ways to fight inflation.
Hard assets are assets with value. For example, a real estate investment in a home or commercial real estate has value. The property values may increase or decrease over time, but they always have a value. Real estate often performs well in an inflationary environment, giving real estate investors a hedge against inflation.
Soft assets are assets without an intrinsic value. They are often intangible and can't be bought or sold. Brand awareness and even human employees can be a soft asset. They are valuable to your business, but you can't sell them to make money.
Best Investment Hedges for High Inflation
Understanding the best investment hedges for high inflation can help you offset the risk of a loss while the dollar's value decreases.
Treasury inflation protected securities, as the name suggests, helps fight against inflation. The securities are indexed to inflation, so your payout is based on the current inflationary environment when you receive your payout twice a year. You can purchase TIPS in 5, 10, or 30-year increments.
If interest rates increase, your TIPS rate increases, and if interest rates fall, your TIPS rate falls too. The government also guarantees TIPS, so you don't have to worry about a loss.
Cash isn't a growth asset, but it can protect against inflation because you can't lose it. Keeping some money safe in a high-yield savings account or CD can ensure that you offset too much loss caused by rapid inflation.
If you'd rather not keep your money in cash, short-term bonds are the next best thing. Short-term bonds are safe and liquid. Because they have short terms, they are less likely to be affected by rapid inflation. Your bonds will mature soon enough, allowing you to invest the money in another asset that might hedge against inflation.
Stocks are a good long-term investment. If you're in it for the long haul, your stocks can ride out the storm, including those caused by inflation increases. It's important not to be too reactive with stocks, though. Inflation increases can be temporary, and if you jump ship too soon, you could suffer an unnecessary loss.
Gold is another investment that can offset the risk of inflation if you can invest for the long-term. Remember that as a short-term investment, gold won't protect you against inflation, so make sure it's a long-term commitment before choosing it.
Commodities are a riskier investment than any of the assets mentioned above, but they can be a hedge against inflation since the price of raw materials increases with inflation. Commodities can be a decent addition to your portfolio, but they shouldn't be the main focus.
Real estate prices often increase with inflation, so they can be a great way to protect your portfolio from the downsides of inflation. For example, if you own rental properties, you can increase rents by keeping the pace with inflation or sell the properties at higher property values as they increase, giving you higher capital gains.
Inflation vs Real Estate
Owning residential real estate during periods of inflation can be a great way to offset your portfolio and set yourself up for success. Here's how the real estate industry and home prices stack up against inflation.
Real estate is a hard asset. It's tangible, increases in value, and can be sold if needed. It always has a value, whether it increases or not, and there's almost always a secondary market for it, even if it takes longer than you'd like to sell.
Real estate has intrinsic value. People need real estate because they need a place to live. Because of its high need, the real estate market often works with inflation rather than against it. Real estate investors often see their investments increase in value rather than fall.
If you're in the real estate business, you likely own income generating assets. Whether you own residential real estate and rent the property out to tenants or you own commercial properties that you rent to small businesses, raising the rent prices as inflation increases, you're earning income while the property value likely increases too.
Pass On Inflation Costs to Tenants
As a real estate business owner, you can pass on inflation costs to tenants in the form of higher rent prices or other costs. As the real estate owner, you don't have to absorb all of the costs. Since it's an income generating property, you can pass the costs along to your clients, preserving your investment in the property.
One of the benefits property owners enjoy is low interest rates, allowing you to leverage your investment. In other words, you can buy a property that's worth a lot more than what you could afford to pay in cash outright. So even if home prices rise during an inflationary environment, real estate investors can leverage their investment and enjoy the higher prices and home values in real estate.
Housing Values Generally Increase Over Time
There's no guarantee, but housing prices and values usually increase over time. If you can commit to the investment long-term, you can hedge against inflation. Getting into the housing market during a slow time may help you negotiate even better deals. Still, even if you get in with rising prices or even high mortgage rates, they will eventually even out while the housing values continue to climb.
Since real estate is limited to what's available in the housing market at the time, it can drive higher prices and even the income of your rental properties. There's only a certain amount of land and properties to go around, and since everyone needs a roof over their head, rising prices may not be detrimental to your quest for more earnings.
What Happens if Interest Rates Rise?
Rising interest rates can be scary, but they don't make that much of a difference in your payment if you do the math. The difference between not investing in real estate and taking a chance with higher mortgage rates can mean the difference between investing in an appreciating asset or losing out on your opportunity to jump into the real estate market.
What Is Hyperinflation?
Hyperinflation is a fast increase in the consumer price index, usually 50% or more within a month. This can often cause hoarding as consumers quickly try to get their hands on products while they are still affordable to avoid the rising prices.
What Happens to Real Estate During Stagflation?
Stagflation, or a period of high unemployment combined with high inflation, doesn't affect real estate much. Because real estate prices increase with inflation, real estate investors enjoy higher returns despite the high unemployment rate.
Investors are looking to real estate to hedge against inflation in big ways today. Whether you invest in REITs and invest a little capital, or you buy physical real estate and pay for property management services to help you manage the properties, there is money to be made in real estate. Even with its expenses, such as upkeep, property taxes, and insurance, real estate keeps pace with inflation, making real estate investing a viable source of income. Learn more by signing up and visiting our blog.
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