Why Investing In Real Estate Is A Great Hedge Against Inflation
Inflation is defined as a general increase in consumer prices and a decline in the purchasing value of money. What this means is that in an inflationary environment the price of goods and services is rising but our earnings remain the same. Unfortunately, in the United States, we haven’t seen periods of high inflation such as this in almost 40 years.
There are many factors contributing to this perilous economic environment that is affecting the global economy such as supply chain disruptions, labor shortages, high construction costs, high real estate prices, fluctuating stock prices, and of course higher interest rates just to name a few of the factors.
In times of high inflation, however, there may be a silver lining. Investing in commercial properties can be one of the best hedges during times of higher inflation, and here’s why: because real estate assets particularly multifamily properties are investment opportunities that remain in strong demand because as the prices of goods increase so too do the rents on these properties. And as we know with increased rents comes increased real estate returns for potential investors who invest in these tangible assets.
Whatever the causes of inflation, the impact on real estate is generally a positive one. The fear of inflation tends to steer savvy investors toward commercial real estate investments such as multifamily housing.
How Does Inflation Affect Commercial Real Estate?
Commercial real estate investors can reap many advantages from the effects of inflation. Keep reading to discover the key ways inflation can have a positive impact on real estate, particularly how multifamily investors can create an inflation hedge.
#1 – Housing Prices
During times of a high inflation rate, such as we are experiencing currently, property values typically rise with inflation. For commercial property owners as well as residential real estate owners, this oftentimes means their assets will appreciate faster. In this particular economic climate, property owners are seeing record-high appreciation rates. Prices will eventually even out, but even then owners have been experiencing a sizable increase in property values of 6-9% creating an exceptional hedge against the ravages of inflation.
#2 – Mortgage Payments
With fixed-rate mortgages, the cost of capital remains the same while the property appreciates at a much faster rate during inflationary times which dramatically increases an investor’s net worth. For example, rents on single-family homes have been on a steady upward swing for some time now. CoreLogic reported that March 2022 data showed a national rent increase of 12.6 percent year over year, and inflationary pressures will hit the rental market as well.
How Is Real Estate A Hedge Against Inflation?
Investing in real estate, more specifically investing in rental properties creates a good hedge against inflation. In most cases, the investors are not only protected from the effects of inflation but can actually benefit from inflation.
Rental Income Increases
With many investments such as stocks, for instance, the value of these investments can decrease during an inflationary period. On the other hand with real estate investments (tangible assets), property values and rental prices increase during times of inflation. Shelter is a basic human necessity, not a luxury. So, individuals will always be seeking housing, which makes this type of investment such as apartment buildings an attractive opportunity for many real estate investors.
According to a recent article in Forbes, the winning formula to profit as a real estate investor during an inflationary period is to tie a cash-flowing property to long-term fixed-interest rate debt. As discussed earlier a fixed-rate mortgage on your investment and the ability to increase rents due to inflation allows for increased cash flow for the investors which is why this type of asset can be such a powerful investment strategy during times of inflation.
Advantages of Commercial Real Estate
In the commercial real estate market, rent increases are very typical and expected. For example, many lease structures allow for an increase in rent annually. With commercial real estate, as rents increase, the value of the property increases as well. If the rent increase outpaces inflation, investors can make a significant positive return.
Let’s explore this example: If you were to invest in an asset with 10% down and inflation rises to 10%, you would have just doubled your down payment, as well as double your equity in the property. You may be asking yourself how a 10% increase in profit can offset the decline in purchasing power of the dollar during inflation.
Here’s why – because the debt on the mortgage is being paid by the tenants. When you receive a higher return on your equity, despite inflation, and you’re leveraging the fixed interest from the bank loan and the tenants’ income, you will ultimately fare better with this type of investment strategy.
The values of commercial real estate properties are often caused by scarcity. This is especially true when there is increased population growth and the housing supply can’t keep pace. Simply put, when demand is high and inventory is low, real estate investors are positively affected, as long as price growth outpaces the rate of inflation. The demand for housing is at an all-time high in the United States, and currently many real estate investors are benefiting greatly from the rise in prices, as well as the increased need for adequate housing.
How Real Estate Compares To Other Investments
Real estate investing typically holds less risk than other investments, particularly the stock market, while continuing to deliver good returns and the opportunity to build wealth. Most financial advisors will tell their clients about the importance of diversification and that is why investing in commercial real estate is highly recommended. The higher gains that one can experience in a commercial real estate investment can offset market volatility or help offset the lower returns from bond and mutual fund investing during inflationary events.
Building Wealth In A Poor Financial Climate
The sustainability of real estate investing is one of the top reasons investors are flocking to real estate, particularly during inflationary times. According to Forbes, “real estate has made more ordinary people wealthy than any other investment vehicle.”
During inflationary periods, the value of your debt diminishes right along with your equity. Many people are turning their equity into debt by implementing cash-out refinances so that they can reinvest that capital into investments such as real estate.
While most individuals are searching for some type of hedge against inflation to protect their capital, real estate investors are reaping enormous benefits while rapidly increasing their wealth and net worth. Investing in real estate can allow you to utilize debt to your advantage while enabling you to continue to build your wealth even in a turbulent financial climate.
Note: We are not financial advisors. We always recommend that our potential investors consult with their financial advisors before making any investment decisions.
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