Adapted from the July 2024 PREP Newsletter
Unless you’ve been living under a rock (and even if you have, have you seen the cost of rocks these days? ;)) the current high-inflation economic environment has likely impacted you. From the high cost of groceries and gas to insurance and travel, prices on just about everything have skyrocketed, impacting nearly every aspect of our lives.
One might inherently think that this high-inflation environment would negatively affect real estate investors. But let’s discuss how this is actually not always the case, and how real estate investments can actually serve as a hedge against inflation and even help us profit from it.
What exactly is inflation?
Inflation is the rate at which the price of goods and services rises over a period of time. The US Bureau of Labor Statistics uses the Consumer Price Index (CPI) metric to track the price of goods and services, and calculates the percentages by which costs have risen—the number that reflects inflation. Many market factors affect inflation, and economists generally agree that some inflation is necessary for economic growth, because it forces people to not hoard cash. It encourages spending and investments, and that helps to grow the economy. If the value of money is diminishing, people will put that cash to use.
However, a period of high inflation can be potentially detrimental, as the value (purchasing power) of money diminishes. The devaluation of our money might outpace our ability to earn new money to make up for that lost value. Whether inflation occurs at stable or high rates, what can we do to protect ourselves against the devaluation of our money? This is where real estate investing comes in. This is because it allows you to not only protect yourself from inflation, but to also profit from the investment.
Here are some ways in which real estate investors can benefit from inflation:
1. Rent Increases Provide Cash Flow
The same way that prices for goods and services increase during high inflation, so does rent. And when demand is high, rental properties aren’t likely to see short-term or long-term vacancies. And when was the last time that you heard rents ever coming down? This provides an increase in steady cash flow to the investor.
2. Yes, Other Expenses Also Go Up During Inflation
It’s true that expenses other than rent) increase during times of inflation. However, unlike most rents, some expenses do come down, while rents have historically risen more rapidly than other expenses, continue to do so, and tend to remain at those higher levels. When the economy slows up, the interest rates come down which allows an investor to refinance their mortgage and lower their debt costs. Same for gas, oil and electric, that an oversupply and a smaller demand can also reduce heating and cooling costs.
3. Increased Demand For Rental Homes
As the cost of borrowing goes up and property values increase, the cost of owning a home is too much for some potential homeowners and fewer people will be able to afford a home or will postpone buying a home. These people will have to turn to renting, driving a large demand for rental properties and creating a competitive pricing environment thus further increasing the value and rents of your real estate investment properties.
4. Property Price Appreciation
The real estate market can experience a reduction in valuations in an environment of rapidly increasing interest rates, like we experienced in 2022-2023. The huge spike in interest rates slowed sales activity and softened the market. However, in the long term, inflation continues to be a strong driver for increased real estate property values and therefore their valuations tend to match or outpace inflation.
Home prices remain high and continue to increase, especially during a period of high inflation, because inflation increases the cost of the materials used to build houses. New construction units are sold at higher prices to reflect higher costs, thereby raising the value of already-built, comparable properties. A byproduct of this is greater income from rising rents. This appreciation positively affects the overall investment at the time of sale.
5. Inflation Can Lessen Debt Ratio
Once a fixed-rate mortgage is acquired, the payment will never change. As an investor, we pay back the bank the same amount of money each month. Of course, taxes and other fees may adjust it slightly, but over the life of a mortgage, inflation will erode the value of the outstanding debt. Inflation lowers the loan-to-value ratio, and it effectively lowers our debt ratio. The property’s equity increases, while the debt decreases. The property appreciates in line with inflation, but your fixed-rate payments stay the same.
So, to conclude, when you invest your cash into real estate investments, you are creating a hedge against inflation and even profiting from it. Just another added benefit of investing in real estate.
Hoping the rest of your summer is healthy, safe, fun, and relaxing!
