Real Estate, a hedge against inflation
Inflation is on the minds of everyone right now.
There are main 3 factors that affect inflation and the value of the dollar;
- Increased demand for products and services,
- Constraints on available supplies for goods and services,
- An increase in the amount of money being printed.
I remember discussing inflation during 2020. I had an inkling that sending economic relief checks during the pandemic would have an impact on inflation. Little did I know constraints on supplies and the demand for products and services would also be a huge driving force. To be honest, the country hasn’t experienced high inflation since the 70’s and 80’s and many Americans are unfamiliar with the economic concept. Strategies to hedge your money against inflation at these levels have been forgotten or never experienced.
With inflation on the rise, the stock market has become volatile, leaving many people wondering where to invest their money for a “safe” return. Real estate has traditionally offered the best hedge against inflation. However, unprecedented price increases over the past 2 years and now an increase in interest rates have many people pushing the pause button.
On the brighter side (if there can be one with inflation), as bad as inflation may seem, “inflation as a response to strong economic growth is a good thing”. Inflation as a response to unemployment and lack of demand is not healthy.
We referenced an article by Nicholas Gerli of Reventure Consulting in our post The Great Deceleration that stated, “Real estate was arguably the best performing asset class of the decade, far outpacing the stock market. The median price of a home in the US more than doubled from $24,000 in 1970 to $55,000 by 1980. Meanwhile, the Dow Jones Index only increased by a meager 17% over the same time frame. And so the perception of real estate, a strong hedge against inflation was born.”
In this article, we will share 3 types of real estate investments for you to consider as a hedge against inflation.
The question is… is real estate STILL a hedge against inflation?
Real Estate investing is a proven wealth-building tool when it is done intelligently. Due to the shortage of housing starts for the past 15 years combined with an unprecedented population growth of the home-buying age, demand for real estate is stronger than ever.
According to Deputy Chief Economist at Freddie Mac, Leonard Keifer, “There are now 18% more people between the ages of 25 and 34 than in 2006. That is 6.6 million more potential first-time homebuyers, from 39.5 million in 2006 to 46.1 million today.”
With the demand for real estate so high, it is important to note this article is regarding the long game of real estate investing. Fix and flip, is a risky move in a market with such volatility. The long-game is referring to holding real estate for 7 plus years.
Here are 3 reasons why real estate is still a good hedge against inflation:
- Over the decades, real estate appreciation has been correlated with the consumer price index, making it a good hedge against inflation over a longer period of time.
- Real estate investments also create monthly revenue, whereas other investment vehicles require you to sell your asset to receive a return on your investment.
- Lastly, the overall debt of real estate investments decreases with each payment while your overall appreciation continues to increase.
What are the best real estate purchases to hedge against inflation?
Here are the top 3 best real estate investments to hedge against inflation.
- Primary Residence
- Long-term Residential Rentals
- Commercial Real Estate
1. Your primary residence as a hedge against inflation
With home prices increasing as well as interest rates, many would-be home buyers are asking, “is now a good time to buy?”
The answer is never simple. It depends on several factors. The two main factors are your monthly payment and how long you plan to own the home (remember – we are talking about the long game)
- What will your monthly payment be? Interest rates and home value are the major factors when determining your monthly payment. Making sure your monthly payment is affordable for your situation is key. With a fixed-rate mortgage, your payment is set. Interest rates can increase or decrease and home values may increase or decrease, but your payment will remain the same.
When you buy your home with a fixed-rate mortgage, your payment is based on the dollar’s value at the time of purchase. As inflation rises, you are actually paying with cheaper dollars over the years.
- How long will you own the home? Many first-time home buyers are facing higher home values and increased interest rates, leaving them looking at less desirable homes without all of the bells and whistles. Buying your first home doesn’t mean you are buying your forever home. Your first home is a great step as your first investment property. Plan to live in your home the first couple of years, when your financial situation is right, look for your next home and rent out your first home. This is a great wealth-building strategy.
CNBC reported a study from 2019, which showed “homeowners in the U.S. had a median net worth of $255,000, while renters had a net worth of just $6,300”
- A mortgage is a forced savings account. Each payment is building equity whereas rent is building someone else’s wealth.
- The tax benefits of a homeowner outweigh those of a renter.
- As a homeowner, you can deduct your mortgage interest.
- If you work from home and have a dedicated home office space, you can deduct a portion of your monthly expenses from your taxes.
- To see additional tax benefits of being a homeowner click here and always consult your tax advisor.
Because we all need a place to live, buying a home as your primary residence is the first step in investing your money as a long-term strategy with substantial tax benefits.
Long-term rentals as a hedge against inflation
Long-term residential rentals can offer a stable and reliable investment. Rents are traditionally correlated with inflation. The US housing shortage has caused a very low vacancy rate, providing landlords with more power to control rent rates. Residential rental rates can change with each leasing period, which is typically every 12 months.
“While real estate is a market that sees the impact of inflation, the ability to adjust rent prices serves as a shock absorber compared to other investments, like bonds,” Gary Beasley, CEO and co-founder of Roofstock.
The chart below was published by Nuveen, a Global Investment Manager, showing rental rates in correlation with inflation on a global level.
Once you are securely in your primary residence, purchasing income-generating real estate is a great option. Locations with higher density, low unemployment rates, and good school zones are the best residential rental investments. A few things you will want to consider:
- Will you have time to self-manage or hire a professional property manager?
- If you plan to self-manage, do you have a list of vendors to cover maintenance requests?
- When calculating your rental income, make sure to consider maintenance costs, taxes, insurance, and vacancy rate.
A note about short-term rentals
With online services like Airbnb and VRBO, owning short-term and vacation rentals has become a hot topic. Due to the pandemic, short-term rentals created 20% more revenue than in prior years. Pent-up demand for travel helped the vacation rental market soar! However, as we have seen in the stock market, pandemic growth does not equal forever growth. Owning short-term rentals as an Airbnb has become a major fad. This isn’t to say it is a bad investment. However, major research is needed before delving into this game. Questions to ask before investing in a short-term rental:
- Does the area allow for vacation rentals – legally?
- How many man-hours will you have to invest?
- Do you have a reputable property manager?
- What will be the maintenance costs?
Commercial Real Estate as a hedge against inflation
Like residential real estate, commercial real estate also offers stability and predictable cash flow. Tangible assets, like residential and commercial real estate, tend to appreciate proportionately to inflation. Like residential real estate, commercial rental rates tend to increase with inflation. However, commercial lease terms typically range from 3-10 years with predetermined incremental rate increases.
Purchasing commercial real estate is typically done by a more sophisticated investor who has substantially more money and more in-depth knowledge of market conditions, compared to the residential real estate investor. In addition, operation costs and legalities are different for commercial real estate.
The complexities of commercial real estate investing causes many investors to shy away, however, REITs (Real Estate Investment Trusts) offer an option. According to Investopedia “Modeled after mutual funds, REITs pool the capital of numerous investors. This makes it possible for individual investors to earn dividends from real estate investments—without having to buy, manage, or finance any properties themselves.”
Some of the more popular REITs are linked below:
Investing for your future
When the market becomes volatile, most people will instinctively want to push pause on making a major purchase, and we don’t blame you. At this point, we are seeing the residential market starting to settle to pre-pandemic levels. Demand for housing and home values remain strong but the year-over-year rate of increase has quickly declined.
The most important thing to remember is that this is the LONG GAME. The real estate market has ups and downs, but fortunately, it has proven to be more predictable than the stock market. Investing in real estate is not like day trading. It is more like a retirement account. Put your money in and leave it be. Investing in income-generating assets like real estate is a great way to hedge your bets against inflation and protect your money.
If you are looking for a somewhat stable arena to invest your money, real estate could be an option for you. To find out more about investing in the Tampa Bay real estate market, call YES-HOMES to discuss your goals.