This allows you to keep up with the rising cost of living. As a result, real estate income is one of the most effective strategies to protect an investment portfolio against inflation.
Is real estate a good way to protect against inflation?
- Inflation is defined as an increase in price over a period of time, such as rising housing or rent prices.
- Excess money supply, supply and demand shocks, and the public belief that prices would rise are all common drivers of inflation.
- Investors use real estate as an inflation hedge by taking advantage of low mortgage interest rates, passing on growing costs to renters in the form of higher rents, and profiting from rising home values over time.
How may real estate be used as an inflation hedge?
While inflation will reduce the net returns of bonds, stocks, and fixed-rate vehicles, real estate managers can lessen the effect of inflation by raising rents at managed properties. Naturally, this does not happen in all properties, property kinds, or markets. Have you ever had a landlord who seemed completely immune to the forces of inflation, leaving you with a ridiculously low rent? In order to properly combat inflation, forethought is required.
Here are a few strategies used by commercial real estate investors to reduce the risk of rising inflation:
- Rent increases are contractually tethered to higher fluctuations in the CPI through CPI indexation. While this may appear unnecessarily bureaucratic, throughout the 1970s and 1980s, when inflation was more rampant, it was fairly standard.
- Rent reviews that are built into leases on a regular basis. This is especially significant with longer-term agreements and/or when the property has few or only one tenant.
- Sponsors may be able to move part of the costs of renovating and managing a property to tenants by shifting operating and capital improvement expenditures to renters. Materials, services, and utilities, in particular, are likely to follow inflation. While this trend may necessitate lower gross rents in order to remain competitive in the leasing market, it can have a significant impact on net operating income (NOI) over the course of lengthier leases. This is true for non-residential CRE asset classes such as industrial, retail, and office.
The basic line is that we believe real estate can serve as a reliable inflation hedge, but only if it is properly managed. As a passive real estate investor, you might want to inquire if the sponsor has a plan in place to keep NOI growing at a rate that keeps up with inflation so that returns aren’t diluted over time.
Why is real estate one of your strongest inflation hedges?
It’s the outcome of several seemingly incompatible variables. On the plus side, the unemployment rate has dropped to 5.2 percent (down from 11.2 percent in June 2020), and Americans now have an extra $2 trillion in savings from the previous year. Manufacturers and retailers, on the other hand, are reporting shortages of everything from diapers to chicken wings, and renting a car in some markets can cost up to $700 per day.
Overall, it portrays a picture of a fast-paced, unpredictable economy that is high on demand, low on supply, and anchored by one major question: how long will this inflation last?
Including assets that are considered hedges is one technique to ensure that the response does not have a negative impact on your portfolio. Simply explained, a hedge is something that moves in the opposite direction of the market or isn’t vulnerable to dramatic volatility. Hedging is included in a diversified portfolio because it can assist reduce losses if the market experiences large fluctuations in response to factors such as inflation.
A variety of assets, including particular types of bonds, gold, other commodities, and real estate, are sometimes marketed as good bets against inflation.
For a variety of reasons, real estate is also on the list. First, let’s look at the impact of inflation on debt. As the value of a home improves over time, the loan-to-value ratio of any mortgage debt falls, creating a natural discount. As a result, your home’s equity grows, but your fixed-rate mortgage payments stay the same.
Inflation favors real estate investors who make revenue from their rental properties, particularly those in property sectors with short-term lease agreements such as multi-family buildings, because increased housing prices generally translate into higher rent. If you can increase your rent while keeping your mortgage the same, you’ll have more money in your pocket.
Finally, because property values tend to stay on an upward trajectory over time, real estate can be a useful inflation hedge. In less than a decade, most of the properties that struck rock bottom when the real estate bubble burst in 2008 were back to their pre-crash prices. Real estate investments can also provide investors with a source of regular income and can keep up with or outperform inflation in terms of value.
Investing in a multi-family property is one approach to use real estate to protect against inflation. Individual rental units, unlike commercial properties such as retail shops or restaurants, which normally have multi-year business leases, usually renew their leases every year. The more apartments in a building, the more frequently you’ll be given the opportunity to change the rent.
Furthermore, multi-family assets, such as apartment complexes, are a unique asset class in that they are always in demand (particularly when housing prices rise), but they also have a high turnover rate of 47.5 percent. Furthermore, due to rising labor and material prices, there may be a restricted supply of buildings or new development projects, causing rental rates and property values to rise. These two variables combined result in a property that is unlikely to stay vacant for long periods of time, as well as multiple opportunities to renew or start leases at market-adjusted rates.
Another factor to consider is that expense reimbursements, which are part of a lease, are another way for real estate to keep up with inflation. Regardless of the type of building structure, leases transmit some form of a property’s operational expenses down to its tenants. In a triple net lease property, for example, the renter is responsible for 100 percent of the property’s expenses. Landlords and owners may be partially sheltered from the affects on the property’s cash flow if utilities and maintenance rates grow in tandem with inflation.
From increased pricing on consumer items to higher interest rates, there are some aspects of inflation that we simply cannot escape. The good news is that, even if the predictions come true, real estate is one way to protect oneself from the other repercussions of inflation.
I’m being completely honest. This website does not provide investment, tax, or financial advice. For counsel on your individual circumstance, you should seek the opinion of a licensed professional.
What happens to real estate when inflation is high?
Many real estate investors are concerned about the impact of rising inflation on their assets and businesses. We see consumer prices rise as inflation rises, but what impact does this have on real estate?
Inflation has a number of real estate-related consequences, including higher mortgage rates, rising asset prices, depreciation of long-term debt, increased building costs, and so on. Let’s look at how inflation affects real estate assets and mortgages, as well as how investors might position themselves in a high-inflation climate.
What investments do well in the face of inflation?
- In the past, tangible assets such as real estate and commodities were seen to be inflation hedges.
- Certain sector stocks, inflation-indexed bonds, and securitized debt are examples of specialty securities that can keep a portfolio’s buying power.
- Direct and indirect investments in inflation-sensitive investments are available in a variety of ways.
Is inflation beneficial to homeowners with mortgages?
- Inflation is defined as an increase in the price of goods and services that results in a decrease in the buying power of money.
- Depending on the conditions, inflation might benefit both borrowers and lenders.
- Prices can be directly affected by the money supply; prices may rise as the money supply rises, assuming no change in economic activity.
- Borrowers gain from inflation because they may repay lenders with money that is worth less than it was when they borrowed it.
- When prices rise as a result of inflation, demand for borrowing rises, resulting in higher interest rates, which benefit lenders.
Is it wise to purchase a home during an inflationary period?
For homeowners: Inflation is a positive thing for property owners for a variety of reasons. The most obvious advantage is that your home’s value rises in tandem with inflation.
How will you protect yourself against inflation in 2021?
If rising inflation persists, it will almost certainly lead to higher interest rates, therefore investors should think about how to effectively position their portfolios if this happens. Despite enormous budget deficits and cheap interest rates, the economy spent much of the 2010s without high sustained inflation.
If you expect inflation to continue, it may be a good time to borrow, as long as you can avoid being directly exposed to it. What is the explanation for this? You’re effectively repaying your loan with cheaper dollars in the future if you borrow at a fixed interest rate. It gets even better if you use certain types of debt to invest in assets like real estate that are anticipated to appreciate over time.
Here are some of the best inflation hedges you may use to reduce the impact of inflation.
TIPS
TIPS, or Treasury inflation-protected securities, are a good strategy to preserve your government bond investment if inflation is expected to accelerate. TIPS are U.S. government bonds that are indexed to inflation, which means that if inflation rises (or falls), so will the effective interest rate paid on them.
TIPS bonds are issued in maturities of 5, 10, and 30 years and pay interest every six months. They’re considered one of the safest investments in the world because they’re backed by the US federal government (just like other government debt).
Floating-rate bonds
Bonds typically have a fixed payment for the duration of the bond, making them vulnerable to inflation on the broad side. One approach to reduce that effect, though, is with a floating rate bond, where the payoff raises in reaction to upticks in interest rates induced by rising inflation.
ETFs or mutual funds, which often possess a diverse range of such bonds, are one way to purchase them. You’ll gain some diversity in addition to inflation protection, which means your portfolio may benefit from lower risk.
How can I keep my investments safe from UK inflation?
Inflation may have dropped in recent months, but savers still have a fight on their hands if they wish to avoid its corrosive effects.
We’ll look at how taking certain risks with your money can help you keep your money’s value above inflation.
Shift longer term savings into equities
You might have some money in a savings account. After all, it’s recommended that you save away roughly six months’ worth of earnings as an emergency fund. However, you may discover that you have more than you require. If that’s the case, think about putting some of it into investments that have a better chance of long-term growth.
Equities have historically been the most successful assets for fighting inflation over the long term but you must be comfortable with your investments rising and falling in value.
Choose your investments wisely
Other investments, if you know where to search, can produce returns that are higher than inflation. Bond funds, for example, could be included in a portfolio of investments because they invest in debt issued by governments and/or enterprises seeking to raise financing. Throughout their lives, bonds pay a defined rate of interest, known as the coupon, and should refund the original capital at maturity. To spread risk, bond funds invest in a variety of debt instruments.
A financial adviser can help you create a portfolio that takes advantage of all available investment opportunities.
Maximise tax efficiency
After you’ve figured out how to fight inflation, think about how tax-efficient your assets are. ISAs and pensions are both tax-advantaged vehicles for saving and investing for the long term.
ISAs allow you to save up to 20,000 a year in tax-free growth and income on investments, as well as tax-free withdrawals. Meanwhile, depending on your taxable income, pension payments may be eligible for income tax relief of up to 45 percent.
When you can afford it and while they’re still accessible, it’s a good idea to take advantage of hefty tax breaks over time. This way, you may take advantage of compound growth or earning returns on your returns to help you keep up with inflation.
Seek expert advice
A sound investment strategy should include a diverse portfolio of assets and the use of tax-advantaged investment vehicles.
We can put together a diversified portfolio that is geared to your long-term financial goals, risk tolerance, and inflation protection. Get in contact with us right now to learn more.