The Three Ways Real Estate is an Effective Hedge Against Inflation
What is inflation?
Inflation is the rise of goods and services over time. It usually occurs when the demand for said goods and services exceeds the supply, or when the numbers of dollars being printed in circulation increase over the time while the actual amount of goods and services those dollars are buying remains static.
Hence the cause of inflation today: Not only has the Covid Pandemic shut down factories and interrupted vital supply chains, but the response of the government has been to inject trillions of dollars into the system (i.e. – literally print money) in order to stimulate the economy to get us out of the brief but dramatic Covid-induced recession of 2020.
Inflation below 2.3% is considered low. Between 2.3 and 3.3 percent it is considered high, and between 3.3 and 4.9 percent it is considered very high. This is why the latest inflation readings above 7% are freaking everyone out – above 7% and we are officially entering the “Hyperinflation” discussion, and for more information on Hyperinflation, just look up Venezuela.
What is a “Hedge“?
A hedge is a “just in case” – something that usually moves in opposition to the market or is not subject to wild fluctuations. Hedging is considered part of a diversified portfolio because if can help minimize losses if the market takes big swings in reaction to events like inflation.
The latest report from the U.S. Bureau of Labor Statistics shows the the Consumer Price Index (CPI), a measure of inflation, has gone up 5% over the past year, the highest increase since 2008. It is the result of a number of factors based on a fast moving economy today that is heavy on demand, short on supply triggered by the ongoing Covid pandemic.
Real estate provides an effective hedge against inflation in this current environment because of three effects.
1.The Effect of Inflation on Debt
As home prices rises over time, it lowers the loan-to-value of any mortgage debt, acting as an natural discount.
Inflation makes it cheaper to service – pay down – debt, as long as that debt has a fixed interest rate. In the same way inflation eats into the value of your cash, it also eats away at the value of your loan. This benefits individuals that have acquired loans or mortgages in the past before the period of inflation kicked in.
If inflation decreases the value of a dollar 7% per year, that means the value of any debt incurred decreases by 7% during that period as well. In other words, it becomes easier to find the dollars needed to pay off a loan on a fixed interest rate as inflation increases over time.
2. The Effect of Inflation on rental Income
Inflation also benefits real estate investors who are earning income from their rental properties, specifically property sectors with short-term lease structures like multi-family properties because higher home prices often equal higher rent.
Especially multi-family units with short-term leases of one year or even less, lease renewals provide an opportunity to adjust rental payments upward to accommodate inflationary changes in costs, thus helping a landlord buffer against the rising costs of inflation.
3. The Effect of Inflation on Property Values
Real estate can be a good hedge against inflation because property values over time tend to stay on a steady upward curve. Inflation devalues nominal assets such as CDs and bonds because the are priced based on a fixed interest rate that they pay, and they thus lose value when inflation is increasing. In contrast, real assets such as real estate are tangible things with fundamental value, so their worth floats up together with inflation.
Key Takeaway:
Investing for inflation is essential for protecting wealth.
Inflation can erode savings, especially if those savings are kept only in cash.
Real estate is an inflationary hedge strategy because:
- it has a fundamental value of its own,
- it appreciates
- it can continuously adjust for the effects of inflation by increasing its leases, and
- it can be financed with long-term fixed interest rates often below the level of rising inflation.
This allows you to protect the value of your investment despite inflation, and even allows your net worth to growth with it.
Leave a Reply
The Three Ways Real Estate is an Effective Hedge Against Inflation
Inflation is the rise in price of goods and services over time. The latest report from th4e U.S. Bureau of labor and Statistics shows that the Consumer Price Index (CPI), a measure of inflation, has gone up 5% in the last year, the highest increase since 2008.
- The Effect of Inflation on Debt
Real estate is an excellent hedge against inflation for three reasons:
As home price rises over time, it lowers the loan-to-value of any mortgage debt, acting as a natural discount. As a result, the equity on the property increases, but your fixed-rate mortgage payments remain the same.
another way of looking at this is if you are locked into a 30 year fixed rate term at 3%, but inflation is rising at 5%, inflation is effectively decreasing the size of your mortgage by 2% every year without you having to pay down any additional principle over that time period.
2. The Effect of Inflation on Rents
Inflation also benefits real estate investors who are earning income from their rental properties, specifically property sectors with short-term lease structures like multi-family properties, because higher home prices often equal higher rent. Multi-family properties are a particularly effective hedge against inflation because 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 a landlord is presented with opportunities to adjust the rent upwards in an inflationary environment.
3. The Effect of Inflation on Property Values
Fixed asset values generally rise over time, and become preferred investment vehicles in times of inflation. over the past year, the average appreciation of real estate has increased 14.5%, a staggering number compared to historical performance. it is important to note that real estate appreciation has varied dramatically over time. According to data from the S&P Case-Shiller U.S. National Home Price Index,
During the 1990s recession, from July 1990 to July 1991 real estate depreciated -2.9%.
During the Dotcom Bubble from March 2001 to March 2002 real estate appreciated 6.8%.
During the Great Recession from January 2008 to January 2009 real estate depreciated -12.7%.
During the Covid-19 recession from March 2020-March 2021 real estate appreciated 13.3%.
Though the national appreciation rate as of April 2021 was 14.5% year over year, there was great regional variation as well. The highest appreciation last year was Austin, Texas, at 42.2%, followed by Boise, Idaho at 35.35, Miami, Florida at 25.8%, and Phoenix, Arizona at 24.8%. This compares to Cleveland, Ohio at 4.8%, Philadelphia Pennsylvania at 7.3%, and Baltimore, Maryland at 9%.
Appreciation rates are constantly changing. A fast-growing market can quickly turn into a negatively appreciated market. It is important to understand what is driving supply and demand in the given market and to understand that today’s appreciation rate does not always equate to future value. nevertheless in an inflationary environment real estate values generally increase along with inflation, providing an effective hedge against that inflation.
No Responses