Many real estate investors have expressed serious concerns about inflation during the last few months. In October of 2021, the U.S. Consumer Price Index (CPI) jumped to 6.2 percent year-over-year. This is the highest percentage recorded in more than 30 years.
The majority of retail businesses and distributors were not prepared for the strongly rising worldwide demand for goods and services. Supply chain slowdowns, fewer available laborers and rent hikes along with spiking energy costs have fueled the higher inflation rate.
Leading economists see no feasible solutions to this problem for the near future. Yet, one very encouraging fact is that real estate has a history of good performance during times of high inflation.
Current Risks to a Favorable Economic Outlook
The U.S. and other global economies entered 2022 with healthy momentum, empowered by comprehensive financial stimulus programs. Contributors to this favorable economic outlook were greater consumer spending, rising numbers in job growth and a strong, reliable housing market.
In addition, problems with the U.S. infrastructure were being addressed, supported by a $1.2 trillion infrastructure package. More worldwide support for the distribution of vaccinations and advanced antiviral medications and treatments was evident.
This fostered the feeling of better control over the spread of Covid-19 and its variants. Moody’s Analytics projected positive growth of the U.S. Gross Domestic Product (GDP) equaling 4 to 5 percent for the year ahead.
Yet, potential risks to this favorable outlook still prevail. The future course of the Covid pandemic and future rates of new cases is unpredictable. Spikes in new cases could cause significant obstacles to a domestic and worldwide economic recovery.
Also, the U.S. Federal Reserve may increase the rate for the federal funds target during 2022. If this occurs, it may strongly impede both consumer borrowing and spending.
How Real Estate Can Be a Valuable Inflation Hedge
Both rents and property market values are closely aligned with rises in consumer prices. For this reason, real estate often serves as an effective hedge against inflation. The occurrence of inflation in today’s economies results partly from a fast-operating economy, which boosts the demand for properties while pushing rents higher.
Real estate functions as a hedge against inflation by enabling landlords to increase rents in markets that have low rates of vacancies. This helps the landlords out-distance rising rates of inflation while potentially increasing profits for investors.
Varied Effects of Inflation on Different Types of Properties
When examining various effects of inflation on different types of properties today, remember that for many years, rising inflation has not automatically affected the performance of property investments. In general, real estate generates steady income even during periods of excessive economic volatility.
Many urban areas in both the U.S. and Europe currently have rental home and apartment vacancy rates that are below average. This enables landlords to increase the rent. Buying a home in the current market is also a hedge against inflation since mortgage rates are now low.
More ways in which investing in different property types can act as a hedge against inflation include the following:
- Commercial Office Buildings. Offices in the United States usually have long-term or intermediate-term rental leases that are typically not index-connected. This protects them somewhat from fluctuating or steadily rising rental rates. Rental facilities for the medical and life sciences industry sectors usually have longer leases.
However, their more complex operating setups often give them less flexibility for relocation. For this reason, entities in the medical and health sciences sector may be forced to pay higher rents to avoid moving to other less suitable properties. The opposite view, of course, is that they may pay lower rental fees at a new location.
- Retail and Home Supply Stores. In the grocery segment of today’s economy, inflation benefits a steady recovery for wages and for consumer buying volumes. This enables store owners and management to afford higher rents.
When demand outweighs supply, as it currently does in the apparel sector, higher prices result, generating greater business revenues. In certain regions in the U.S., Italy and China, luxury retail brands and stores are frequently challenged by inflation. Yet, these stores may benefit from paying lower rental fees.
- Residential Properties. Home properties in the U.S. have traditionally been a low-risk sector of the real estate industry. The majority of home rentals have short-term leases, which supports fast rental fee adjustments.
This is a definite advantage for investors in buy-and-hold properties during periods of rising inflation and low home vacancy rates. These investors can raise rents and be reasonably assured of stable tenant occupancy rates.
However, the housing segments of the economy in European countries like Germany, the Netherlands and Sweden provide fewer opportunities for rent increases by landlords. These markets are strongly regulated. Japan is currently the one Asia-Pacific country with a plentiful, liquid supply of multifamily properties. Here, increasing inflation rates have only a small effect on possibilities for rental growth.
Housing Plus Low Interest Rates Equal a Sturdy Inflation Hedge
During times of rising inflation, prices for nearly everything rise, real estate included. Yet, by locking in a fixed-rate mortgage with low interest, your home cost will remain the same while your home’s market value increases. As an appreciating asset, your home is a wise and reliable investment.
If inflation is predicted, you want to place your money carefully to prevent it from plummeting in value. Especially when interest rates are at a low point, housing is considered an excellent inflation hedge.
Leaving cash in your savings account would be considered a poor hedge against inflation. Although your bank is likely to pay greater interest rates during any inflationary period, the cash value is not likely to show higher performance than inflation.
Three Ways Buying a Home Is a Dependable Inflationary Hedge
Since inflation typically triggers rising prices for homes, mortgage rates and rental fees, you may wonder why buying a home is a hedge against inflation. Yet, buying a home during a period of inflation can benefit you later in the three following ways:
- Lock In a Low, Fixed-Rate Mortgage. Today the average rate for a 30-year, fixed-rate mortgage is in the low three percent range. Obviously, this is an ideal time for borrowing money. With an increase in inflation, mortgage rates are expected to rise. Anyone who locks in a low rate today can avoid being charged higher interest rates in the future.
- Protect Yourself from Rent Increases. If you purchase a home before or at the onset of a period of inflation, rising costs to tenants in the home rental market will not affect you. You will be glad to be protected from this issue as a homeowner with a low interest, fixed-rate mortgage.
- Benefit from the Increasing Value of Your Home. Assets like real estate gain value over time. This always makes purchasing a home a wise and profitable way to spend your money during inflationary periods.
Advice for Home Buyers and Investors from Financial Professionals
In general, the one thing that can help you gain equity in your home is time. Of course, if a housing market boom should occur, your house may appreciate faster than usual. It may surpass the current average appreciation rate significantly, which is three to five percent.
The current housing market is the perfect example of rapid price appreciation for homes. Yet, even if you pay a high price point for your home property, you can benefit by living in your new home for the long-term.
Many bank executives and financial advisors remind us today that residential properties that were purchased just before the 2008 Great Recession have appreciated greatly in value since then. If, however, you are a home property investor with plans to buy and flip a home today, you should be somewhat wary of this speculative move, according to these financial professionals.
Overviews of Property Fundamentals Show Strength
Current overviews of property fundamentals are strong. Major areas of strength in the market are the industrial, multifamily and life sciences sectors.
- Industrial/Warehouse Sector. The solidity of the high-performing industrial/warehouse segment has been fueled by continuous disruptions in the supply chain, rebuilding of inventories and the sharp upswing in e-commerce today. With lofty demand levels and a significantly low vacancy rate just upwards of 3.5 percent, reliable rental growth is expected to continue in 2022.
- Multifamily Sector. The multifamily property sector remained significantly healthy during the pandemic and continues to show increasing strength. Property vacancy rates are currently at an average of 2.9 percent, the lowest percentage since 1994. Steady growth in jobs and young families in the U.S. are predicted to spike demand for rental units during 2022 and in future years.
- Life Sciences Sector. Research and development combined with active venture capital funding in the life sciences sector has increased the demand for life sciences real estate. This high-performance industry segment is well fueled by constant and widespread healthcare needs.
The commercial office building market is predicted to begin recovery in 2022, with some workers returning to company offices. Yet, a significant number of employees will continue to work virtually from home. There are also welcome signs of recovery in the retail sector, especially in community shopping malls. This improvement is supported by the current spike in the suburban housing market throughout the U.S. today.
Real estate has a solid history of high performance during inflationary times. Even during periods of high inflation that strongly affect local, national and global economies, real estate has proven to be an effective hedge against the ill effects of inflation. The current predictions for increasing inflation during 2022 are pushing prices higher for goods, services and housing expenses across the U.S. and beyond.
Yet, home buyers can now benefit from low-interest, fixed-rate mortgages. Owners of multifamily properties can benefit from raising rents in low-vacancy apartment buildings. These two factors keep real estate investors interested and active in both single-family homes and multifamily property investing.
Both the commercial office building and retail facility real estate sectors are showing increasing signs of recovery for 2022. Leading the overall empowerment of the real estate industry for this year are the industrial/warehouse, multifamily and life sciences sectors of the REI market. These market segments are proving the power and validity of the statement that real estate is a great and reliable hedge against inflation.