This article is part of our guide on buying real estate during a recession, available here.
The Ukraine conflict, the COVID-19 pandemic, and a never-ending global commodity supercycle have caused inflation to reach 40-year highs. The consumer prices, such as goods and services, are also influenced by additional, interrelated factors like fiscal policy, business policy, and production costs.
Given that the asset class typically has a low correlation with equities and bonds, investing in real estate is regarded as one of the best strategies to protect against this rising inflation. So, how good is real estate for inflation hedging?
Even though the stock market and a mutual fund might appear like intelligent investments, income-producing real estate will save you during a downturn.
A Brief History on Inflation
The rising prices and the gradual but consistent loss of purchasing power over time are both examples of inflation. Since rising inflation happens so gradually, most people aren’t even aware they are getting less value for their dollars.
The Consumer Price Index (CPI), the Personal Consumption Expenditures Price Index (PCE), and the Producer Price Index (PPI) are the three primary methods by which the government or Federal Reserve and investors in the United States gauge inflation.
Inflation has been relatively low and constant for several decades following the inflationary spirals of the 1970s and 1980s, fought with high-interest rates. It is partially because central banks in major western nations have specifically targeted inflation as a vital instrument for managing the economy.
Additionally, several structural variables have contributed to price stability, such as enhanced global labor migration, commerce globalization, labor market conditions, and the role of technology and online retail in fostering price rivalry amongst merchants. These elements operate together, making it more difficult for employees to demand more significant compensation.
However, the pandemic’s recent economic growth has been affected by an increase in oil prices due to the Ukraine conflict, which has caused inflation to return to levels not seen in more than four decades. Its sparked worries that the elements that helped historically keep inflation low may no longer do so in the coming years.
Is Real Estate a Good Hedge Against Inflation?
Inflation benefits hard assets like rental real estate. A hedge in the context of fighting against inflation is a sort of investment strategy that aids in shielding owners and investors from the declining purchasing power of money when inflation takes hold. Our analysis of historical inflationary tendencies and the expertise of our team demonstrate that investments in commercial real estate (CRE) such as multifamily real estate, can serve as a hedge during periods of above-average inflation.
Real estate is generally seen as a strong inflation hedge since it tends to keep up with rising costs.
There are a few good reasons to use real estate investments as inflation hedges, including the following:
- Intrinsic Value
- Value Appreciation
- Debt Depreciation
- Repricing of Leases
- Rising Cost to Build New Product
1.) Intrinsic Value
Unlike soft financial assets like bonds and stocks, real estate is a hard asset. Due to its natural scarcity and limited availability, hard or real assets have inherent value.
Real estate is unique because it has two essential components that are both in finite supply and satisfy a fundamental human need. They are as follows:
- The land
- The building
There is a finite supply of land, which is why it is so expensive. Building-wise, there is currently a shortage of affordable housing in the United States, and it’s hard to economically make sense of building more affordable housing with where costs are today. All this makes real estate the perfect inflation hedge.
2.) Value Appreciation
In the past, real estate values have risen over time, surpassing annual inflation rises. If you choose to invest for the long run, you will always succeed if you choose proper cash flow producing properties to acquire and manage appropriately.
Cap rates are still falling nationwide, and natural rent growth, closely related to asset values, contributes to rising asset prices.
3.) Debt Depreciation
Debt depreciation is another way to use real estate to combat inflation. In essence, borrowers who utilize debt to fund their real estate ventures return the funds they borrowed, but as time goes on, the loan’s original principle is worth less than it did when the debt was first assumed.
One of the best commercial property types is multifamily, which has kept pace with inflation. Generally, a landlord can raise rents yearly by the same percentage as natural inflation.
4.) Repricing of Leases
Landlords can increase rents or reprice leases to counter the rising business costs when inflation drives up expenses. For example, most leases in the self-storage sector are month-to-month contracts or a monthly payment. This allows owners to respond immediately to inflation by raising rents to ensure higher rental income/higher rents and keep property values stable.
Good Read: Hyperinflation & Real Estate Investing
5.) Rising Cost to Build New Product
The expense of constructing new units limits real estate supply. Cost-increasing factors like inflation make it more challenging for developers to create an affordable product that yet makes financial sense for them.
As a result, it raises the value of existing structures because it would be much more expensive and riskier to construct the same type of product today.
Which Specific Type Employs the Strongest Inflation Hedge?
People want to know how to protect themselves against inflation in an inflationary environment and where they should put more money to prevent it from depreciating.
The solution is private real estate investments, which provide you with all the tax advantages that personal and direct ownership provides you for investment vehicles like multifamily real estate. It is a reliable investment that pays investors back their capital contributions from day one and provides significant capital appreciation throughout the course of holding the property and the real estate income it produces during uncertain times.
More importantly, it includes all the qualities described above that make real estate a good hedge against inflation.
We have covered all bases regarding real estate as a hedge against inflation. However, a few frequently asked questions (FAQs) regarding why real estate is a good hedge against inflation need to be answered.
Frequently Asked Questions About Why is Real Estate a Hedge Against Inflation
The best way to hedge against inflation is multifamily real estate due to supply and demand, its income-producing ability, tax advantages, and forced and natural appreciation, to name a few.
It acts as an inflation hedge due to its intrinsic value, the depreciation of debt, the repricing of leases annually, and as replacement costs rise due to rising costs.
Real Estate as a Hedge Against Inflation- Conclusion
Your wallet may suffer from inflation, but you can take action. One effective defense against inflation is private real estate investing. Join the Investors Club here at Willowdale Equity to get access to exclusive value-add multifamily real estate investment opportunities across the southeastern United States.
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- Our Private Investor Portal
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