Is Real Estate Really an Inflation Hedge? What History Says
January 20, 2023
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In today’s rapidly changing economic environment, investors are looking for assets that can help protect them from various market conditions.
Among asset classes, there is a lot of talk about real estate being an inflation hedge. What does history tell us about the past performance of real estate investments during periods of high inflation?
This article will explore how real estate performed in historically high-inflation markets to give investors a better idea of whether or not investing in real estate provides good protection against rising prices.
The Connection Between Real Estate and Inflation
Inflation is a measure of the overall increase in price for goods and services across an economy, affecting investments like stocks, bonds, and real estate.
Inflation is also a silent thief that erodes the purchasing power of your money. When inflation rises, it means $100 today may not be enough to buy what you need in five years.
Investing wisely and diversifying your portfolio can help protect against devaluation due to rising prices — a significant aspect of financial planning.
When it comes to inflation, there is no definitive “high” or “low” rate. What may be considered high for one economy may be low for another. In Argentina, for example, the average inflation rate was 215.4% per year between 1980 and 2019, representing an overall price increase of 111,573,441,219.73%.
The Federal Open Market Committee (FOMC), the monetary policymaking body of the Federal Reserve System, has specified an inflation target of 2%. However, current inflation measured by the Consumer Price Index (CPI) is 6.5% for all items (as of December 2022).
In an effort to bring inflation down to the Fed's target, the Federal Reserve interest rate (federal funds rate) is between 4.25% and 4.50% (as of December 2022).
The reason for raising the federal funds rate is to reduce inflationary pressures in the economy. The rate increase makes it more expensive for banks to borrow money, thus discouraging borrowing and spending. This decrease in investment causes a drop in aggregate demand, which helps lower inflation.
Additionally, the higher federal funds rate reduces the amount of money circulating in the economy, decreasing inflationary pressures even further. This process is known as a contractionary monetary policy, and it’s considered an effective tool for keeping inflation under control.
The pace at which the Federal Reserve is able to bring inflation down to 2% remains to be seen. This uncertainty can worry investors and may compel them to seek out real estate as an effective hedge against rising prices.
How Has Real Estate Historically Performed during Inflationary Periods?
With real estate, high inflation can be a double-edged sword. Inflation can result in higher real estate prices as demand increases and supply remains short. During inflationary periods, real estate prices historically keep up when adjusted for inflation, which may be why real estate is considered an inflation hedge.
(Source: “Inflation Adjusted Housing Prices”)
Rents also tend to rise along with prices when there is high inflation, making investing in rental properties attractive to investors. Furthermore, real estate investments tend to be illiquid and long-term, meaning you don’t need to worry about short-term market fluctuations as much.
However, remember that although real estate can be an effective inflation hedge, it is still subject to the same economic forces that drive inflation in the first place.
Inflation erodes the value of money, which can reduce investors' returns due to rising costs associated with mortgages or renovations. Therefore, your investment decisions should always consider the current state of the economy and likely future trends when deciding to add real estate to your portfolio.
Benefits of Investing in Real Estate during an Inflationary Period
Real estate can offer a delta-neutral hedge against inflation. Delta neutrality is the concept of maintaining a balance between long and short positions to reduce risk or take advantage of other opportunities without taking on additional risk.
Real estate investments act as natural hedges against inflation, as the value of real property tends to rise over time with increases in the Consumer Price Index (CPI).
Several investment strategies utilize real estate to hedge against inflation, such as purchasing REITs, investing in emerging markets, owning tangible real estate assets, or investing in real estate debt. Buying real estate for cash can also help to protect your wealth.
If you are paying cash for the property instead of taking out a loan, you won’t have to worry about rising interest rates and mortgage repayments. Plus, if the value of your currency starts to decline due to inflation, owning physical property can help preserve its buying power over time.
Real estate investments may provide a steady stream of cash flow from rental income or mortgage interest receipts for lenders, which serves as a hedge against inflation.
As the cost of goods and services rises with inflation, investors can benefit from increased rents or rising interest rates on their property. This helps them stay ahead of inflation and maintain their returns even when prices increase.
In addition to cash flow, real estate investments can also appreciate over time due to property appreciation. Home values tend to rise with periods of high inflation as people seek shelter from rising prices by investing in real estate assets.
If real estate investors purchase property at the right price, they could potentially make significant gains from real estate investments as property values rise due to inflation.
What to Look for When Investing in Real Estate
Location is a critical factor when investing in real estate, such as single-family rentals (SFRs).
Investing closer to affordable metropolitan areas, such as near universities and hospitals, may be more likely to generate stable rental income due to demand. Due to high tenant demand, single-family homes within a desirable neighborhood or near central employment centers may also generate consistent rental income.
Investors should also consider the strength of the local job market when considering SFR investments. Assess job growth and migration patterns from other areas and general economic stability and development opportunities that could affect property values over time.
Freddie Mac data reveals how the pandemic has led to a threefold increase in migration from expensive metro areas to more affordable ones. It also shows people are leaving fast-growing metro areas due to the housing shortage and high house-price-to-income ratios.
Infrastructure investment in the area is another essential point to consider. Investment in infrastructure can improve the quality of life for residents and businesses, creating a desirable environment that attracts potential homebuyers.
Better road networks and public transportation systems can make getting around easier. Investment in leisure attractions such as parks and playgrounds can help enhance the local area.
Additionally, before investing in real estate, assess the cost of living in the area to determine if local costs exceed what tenants can afford.
Investors should also consider whether or not rent payments cover all associated maintenance and tax expenses. Examine local housing market trends to determine if single-family rentals are a viable long-term option that provides a positive return on investment (ROI).
Strategies for Creating a Secure Portfolio with Real Estate as a Hedge
Diversification is one of the primary investment strategies to protect against inflation. Investors can increase their chances of success by investing in various real estate assets, mitigating risk and maximizing returns.
For example, a portfolio consisting of commercial real estate properties and residential ones, or a combination of real estate equity and debt, may be less likely to suffer severe losses during an economic downturn than if all investments are in the same sector.
Historically, investors have successfully used investment diversification and other strategies to protect their portfolios from inflation’s effects. In the 1970s and early 1980s, when inflation reached a high of nearly 15%, strong investment returns were achieved by investing in real estate assets, according to an FDIC report.
By diversifying investment portfolios between different types of investment vehicles and geographic locations, investors managed to weather these turbulent economic times relatively unscathed.
More recently, during the 2008-2009 recession, when inflation was over 5%, investment strategies focused on cash flow properties such as single-family rentals proved effective in mitigating losses caused by falling housing prices.
As home values declined significantly during this period, those who had purchased investment-grade single-family homes saw healthy returns due to continued rental income and reduced investment risk.
High Cash Flow Real Estate
Building a portfolio of properties with different levels of risk is another way to guard against the effects of inflation. Inflation affects investment returns differently depending on the asset class, and some investment strategies become more appealing as inflation rises.
For example, investing in high cash flow real estate can be an effective way to hedge against inflationary periods because rental properties tend to maintain their value over time and generate a steady source of income. As inflation rises, so will rents, further increasing investment returns.
Investing in Debt
Debt investing is another strategy to consider when building an anti-inflation portfolio.
Real estate debt investments are attractive because of the generally shorter investment timeframes and the lower potential risk. The shorter term means investors can typically anticipate cash flows more accurately and plan their expenses accordingly.
Compared to real estate equity investments, debt investments do not require taking on ownership or management responsibilities, which can be lengthy and complex processes with uncertain outcomes.
Also, lenders have the first claim to any proceeds from a sale or refinancing of a property. Therefore, the risk is reduced substantially for those who invest in debt instruments.
Crowdfunding is becoming increasingly popular among real estate investors as an effective way to diversify their investment portfolios. Pooled funds allow individual investors to potentially fund larger investments with less risk rather than investing in one single asset.
Furthermore, crowdfunding offers access to investment opportunities that may be more difficult to obtain through traditional investment channels, such as those in emerging economies or other illiquid markets or fractional investments in real estate debt.
Expanding one’s network of contacts can also provide added value when investing during inflationary periods. Experienced real estate professionals well-versed in local market conditions can offer valuable insight into management strategies that could improve investment returns while minimizing risk.
With an expanded network, investors may gain access to investment opportunities that may not be readily available in public markets. This can also provide investors with an edge during inflationary periods.
Investors in the current environment must be mindful of inflationary pressures and take appropriate steps to protect their investment portfolios accordingly. With proper planning and execution, there are strategies that can help safeguard one’s investment portfolio during economic uncertainty.
Using a diversified approach to investing that includes real estate, debt investing, crowdfunding, and building a network of contacts, investors can effectively guard against inflationary effects. At the same time, they may potentially achieve higher returns than if they had only pursued traditional investment vehicles.
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This information is educational, and is not an offer to sell or a solicitation of an offer to buy any security which can only be made through official documents such as a private placement memorandum or a prospectus. This information is not a recommendation to buy, hold, or sell an investment or financial product, or take any action. This information is neither individualized nor a research report, and must not serve as the basis for any investment decision. All investments involve risk, including the possible loss of capital. Past performance does not guarantee future results or returns. Neither Concreit nor any of its affiliates provides tax advice or investment recommendations and do not represent in any manner that the outcomes described herein or on the Site will result in any particular investment or tax consequence.Before making decisions with legal, tax, or accounting effects, you should consult appropriate professionals. Information is from sources deemed reliable on the date of publication, but Concreit does not guarantee its accuracy.