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.