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 an 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.
Is residential real estate a safe haven from inflation?
Because real estate has low correlation with equities and bonds, it is thought to be a good way to hedge against inflation. As a result, investor interest is skyrocketing despite a scorching real estate market, a scarcity of homes, and the possibility of rising mortgage rates.
Does real estate provide inflation protection?
Real estate prices and rents not only tend to keep up with inflation, but they also fuel it. As a result, they frequently increase at a quicker rate than the official CPI inflation index.
According to the Federal Reserve, the median US home price in the third quarter of 1991 was $120,000. Despite inflation accounting for only a part of the increase, home prices in the third quarter of 2021 reached a median value of $404,700, more than three times more than in 1991.
Because, well, real estate is real. It’s a tangible asset with inherent value. People need and seek money regardless of the currency, and they change their offers to buy or rent it as needed to secure it. As a result, it is one of the most reliable inflation hedges.
Does inflation boost real estate?
Real estate prices rise in tandem with inflation as the cost of living rises. In general, when inflation rises, housing and other real estate asset prices rise with it. However, because mortgage rates are rising, this tends to exert downward pressure on real estate demand as debt becomes more expensive.
During hyperinflation, what happens to real estate prices?
Rising rental property rates are likely positives during periods of high inflation. It might be difficult to obtain a mortgage during periods of high inflation. Because high mortgage rates limit buyers’ purchasing power, many people continue to rent. Increased rental rates arise from the boost in demand, which is wonderful for landlords. While appreciation is a different market study, in general, in an inflationary economy, housing values tend to rise. People require roofs over their heads regardless of the value of their currency, hence real estate has intrinsic value. You’ll almost certainly have a line out the door if you can offer advantageous rates for private mortgages.
The increasing cost of borrowing debt is one of the potential downsides for a real estate investor during inflationary times. To avoid being shorted, the bank will charge higher interest rates and provide fewer loans. Another downside is the increased cost of construction materials for new residences. New building can be a tough investment during inflation due to the high cost of borrowing and the increased expense of construction. When money is tight, travel is frequently one of the first things to go. Vacation rentals, tourist destinations, and retirement communities may not perform as well as other real estate investments.
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.
How do you protect yourself from hyperinflation?
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. A floating rate bond, on the other hand, can help to reduce this effect by increasing the dividend in response to increases 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.
Should I sell my home when inflation is high?
The most obvious advantage is that your home’s value rises in tandem with inflation. With low supply and high demand, sellers can set their asking prices as high as they like and, in many circumstances, receive offers that are equal to or even more than their asking price.
Is inflation beneficial to real estate investors?
I admit that I’m old enough to recall the 1970s flares, discos, and collars.
But not just the modest 2 or 3 percent inflation of the previous year, but true double-digit inflation, the kind that saw the price of a Marathon go from 2 pence to 2 and a half pence overnight. Indeed, following the 1973 oil shock, when the price of oil tripled (are there any parallels here with our current economic woes?) For the rest of the decade, inflation stayed in double digits, peaking at 24 percent in 1975.
The Consumer Price Index is now rising at 3.3 percent (1.3 percent higher than the official objective of 2%), while the Retail Price Index (excluding mortgage interest payments) is rising at 4.4 percent (not far off 2 percent above its old 2.5 percent target).
However, most of us believe that these data understate the true situation. Majestic, the wine retailer, said that wine prices would have to climb by 10% to meet transportation expenses and the increasing euro, and that banana prices would rise by 8%.
The majority of this inflation comes from outside the country, in the form of increased gasoline and food prices. Twelve of the 55 countries surveyed by the Economist have double-digit inflation rates.
Inflation, according to most economists, is bad for economies. Consider what is happening in Zimbabwe, when buying a loaf of bread from the local market requires a barrow load of cash. Consumers and businesses find it difficult, if not impossible, to make economic decisions due to the lack of pricing stability.
Landlords, like all consumers, are affected by growing costs and prices. Landlords have been hit hard by enormous labor price inflation in recent years, as skill shortages have driven up the cost of hiring all trades, including plumbers, builders, and decorators.
Other expenses, such as accounting and buy-to-let insurance, are also rising.
The one huge benefit of inflation for landlords is that, because many landlords use a buy-to-let mortgage to fund an investment, their loan charges are the most expensive part of their rental company. Inflation, on the other hand, is excellent news for borrowers like landlords, and here’s why.
If a landlord takes out a 100,000 interest-only buy-to-let loan over 20 years in a zero-inflation country like Japan, that buy-to-let mortgage will still be worth 100,000 after 20 years. Consider the case when inflation is running at the Bank of England’s current target rate of 2%. This means that the buy-to-let loan’s true real value will have decreased to 67,297 after 20 years.
Consider a scenario in which inflation is twice the Bank of England’s target rate, with a long-term average of 4%. In this case, the loan’s real value drops to 45,639, which is less than half of its original value.
As a result of declining property values and rising buy-to-let loan costs, being a landlord may not seem like a great place to be. Inflation, on the other hand, may be just what landlords need to reduce the real value of their buy-to-let loans. There is a silver lining to every dismal sky, as the clich goes. In this scenario, inflation may very well be the culprit!
What do you do with cash when prices rise?
Maintaining cash in a CD or savings account is akin to keeping money in short-term bonds. Your funds are secure and easily accessible.
In addition, if rising inflation leads to increased interest rates, short-term bonds will fare better than long-term bonds. As a result, Lassus advises sticking to short- to intermediate-term bonds and avoiding anything long-term focused.
“Make sure your bonds or bond funds are shorter term,” she advises, “since they will be less affected if interest rates rise quickly.”
“Short-term bonds can also be reinvested at greater interest rates as they mature,” Arnott says.