Did you know that The real estate market can be a great vehicle to diversify a portfolio? Its prices are not closely correlated with the stock market, and it isn’t influenced by investor sentiment because its properties are generally illiquid. While protecting investors against market volatility, real estate can also back off inflation.
Throughout this article, we will explore what causes inflation, how it affects multifamily investments, and what makes real estate an inflation hedge.
Let’s get started.
Inflation can result from demand-pull or cost-push factors. Demand-pull inflation characterizes the majority of inflation. These two causes of inflation are influenced by a number of economic factors.
Eventually, prices for a wide range of goods and services are expected to increase in both scenarios. Due to reduced demand for goods and services from the COVID-19 pandemic, inflation in the United States has been low since the Great Recession, and currently, it has just jumped.
The annual inflation rate in the US accelerated to 5.4% in June of 2021 from 5% in May, hitting a fresh high since August of 2008, and well above forecasts of 4.9%. The biggest price increases were recorded for used cars and trucks (45.2%), gasoline (45.1%), fuel oil (44.5), utility gas service (15.6%), and transportation services (10.4%). Shelter costs were up 2.6% and food 2.4%. Inflation has been on the rise this year amid low base effects from 2020 and as the economic recovery picks up, business restrictions ease and demand surges amid widespread vaccination and federal support. Meanwhile, high commodity prices, supply constraints and higher wages as companies grapple with a labor shortage continue to weigh on the CPI.
In comparison with other investments such as stocks and bonds, real estate is a physical asset that has intrinsic value. In addition to the value of the actual property and its improvements, real estate also has the potential to generate rental income.
Multifamily real estate investments can, therefore, generate returns both in the form of rental income (or other services, such as reserved parking) and appreciation in value. In spite of turbulence in the financial sector, multifamily properties continue to rent since people need a place to live no matter what.
Rising inflation increases prices for goods and services, including new homes. It is likely that the increased costs will pose a challenge to first-time homebuyers, which will lead to higher rental demand. As the demand for rental housing increases, multifamily operators can set higher asking rents. It is likely that the rental income increase by renters will exceed inflationary increases in expenses. Furthermore, increasing rental rates, which account for most of a property’s revenue, could also have a positive impact on asset values.
A weaker currency weakens the purchasing power of fixed returns, such as bonds’ yields, which is why inflation increases. Investors therefore typically seek multifamily real estate, which can gain in value in an inflation-affected environment, to offset the impact of inflation.
While the purchasing power of the currency falls during inflation and the dollar may be required to pay for expenses more frequently, multifamily rents commonly increase at the same time. This along with the increasing value of the property can help gain significant value as inflation grows
The increase in rental income (and potentially other sources of income at a property) may help multifamily investments compete against inflation in higher prices for other goods and services. In addition, appreciation of multifamily values helps erode inflation’s impact on currency value. Finally, real estate-based debt tends to come in the form of long-term finance with fixed interest rates, which ensures that payments remain stable during inflationary periods. Investors are likely to benefit greatly from fixed debt payments as rents and property values rise.
Inflation is a rise in the price of goods and services, which decreases the value of the currency. In turn, investors’ money may lose purchasing power. Nevertheless, real estate investments can offer inflation protection. A multifamily properties’ rents typically rise and property values appreciate during inflationary times, outpacing inflationary movements, while the fixed debt repayments stay the same. As such, multifamily real estate investments may do well, and this is a good reason why investors may want to consider real estate crowdfunding investments for their portfolios.