Although rising housing expenses are expected to reduce slightly in the coming year, as long as inflation remains high, the cost of purchasing a home will continue to rise. Housing costs are expected to grow 16 percent year over year (YOY), according to The Motley Fool. That means a $400,000 house in 2021 will cost $464,000. Potential home buyers who saved $80,000 (20%) for a down payment on a $400,000 house will now need to come up with an additional $92,800 for the same home.
Higher Rates May Slow Rising Home Values
When mortgage rates rise, more homes become unaffordable. As a result, there are fewer active buyers on the market, lowering housing demand. While there is still a significant lack of properties on the market, lower demand and fewer buyers tend to lower property prices. Higher mortgage rates are likely to halt the runaway surge in home values observed during the previous years, even if they don’t push property prices down.
What happens to the home market when interest rates rise?
During inflationary periods, practically everything increases in price, including housing costs and rent, as well as mortgage interest rates. With real estate, there are three basic strategies for investors to protect themselves from inflation and rising costs.
- Take advantage of low interest rates: According to Freddie Mac, 30-year fixed rate mortgage interest rates are now averaging 3.07 percent (as of October 2021). Low interest rates allow an investor to take advantage of inexpensive money now in order to avoid paying higher rates later.
- Exporting inflation to tenants: Having a single family rental home may allow an investor to pass on rising costs to a renter in the form of increased monthly rent. Vacant-to-occupied rent growth has climbed by 12.7 percent year-over-year, according to Arbor’s most recent Single-Family Rental Investment Trends Report, compared to the current reported rate of inflation of 5.4 percent. Since May 2020, yearly rent growth for single family houses has averaged 8.1 percent, compared to a historical average of 3.3 percent. In other words, recent rent price growth has exceeded inflation by 2.7 percent to 7.3 percent.
- Benefit from rising asset values: Housing prices have a long history of rising, which is one of the reasons why investors utilize real estate as an inflation hedge. The median sales price of houses sold in the United States has climbed by 345 percent since Q3 1990, and by approximately 20% since Q3 2020, according to the Federal Reserve.
Is growing inflation beneficial to the real estate market?
The shelter index grew 0.4 percent month over month, while the rent and owners’ equivalent rent indexes also up 0.4 percent. Similarly, home prices in the United States are continuing to rise, up 19.8% year over year, according to recent data from the S&P CoreLogic Case-Shiller Indices.
Inflation, in a nutshell, is the progressive rise in the price of goods and services in a specific market. And when the general price level rises, each unit of currency can purchase fewer goods and services. As a result, inflation is defined as a decrease in the purchasing power of money. A common statistic of inflation is the inflation rate, which is defined as the annualized percentage change in a general price index.
Inflation wreaks havoc on the economy’s pricing structures, forcing individuals and businesses to make less-than-optimal spending, saving, and investment decisions. Furthermore, when inflation occurs, economic players frequently take steps to protect themselves from its negative consequences, diverting resources away from more productive activity.
In the end, wasteful actions can reduce earnings, stifle economic growth, and reduce living standards. Because of these wide-ranging distortions, inflation must be kept low in order to stabilize the economy and promote the productive use of resources.
Real estate has always been thought of as a great inflation hedge. According to researchers from the University of Pennsylvania’s Wharton School, the US consumer price index (CPI) reached 13.5 percent in 1979, the highest level since 1947. The average dividend income from REITs trading on the stock exchange that year was 21.2 percent, which is interesting. In addition, annualized consumer price inflation in the first eight months of 2011 was 5.1 percent. REIT returns, which averaged 8.4% annualized total returns over this time period, once again protected purchasing power.
REIT dividend growth averaged 7.71 percent per year between 1978 and 2011, while consumer price inflation was only 3.92 percent. To put things in perspective, REIT dividend income beat inflation in 306 of the 404 months. Because of these factors, REIT returns were able to keep their purchasing power throughout the era.
On private real estate, similar consequences have been observed. Private real estate total returns were robust throughout inflationary years, according to a 43-year examination of the NCREIF Property Index. The 12-month period ending in Q3 2021, for example, saw annual real GDP growth and inflation rates of 4.9 percent and 5.4 percent, respectively, but the NCREIF Property Index grew at a solid annual pace of 12.1 percent.
During periods of rising inflation, owning real estate has a lot of advantages. First and foremost, as property values stay pace with inflation, owners will experience an increase in value. Furthermore, as a result of increased labor, material, machinery, and other costs, fewer real estate development projects are undertaken, resulting in a decrease in property availability, leading to further price hikes.
Second, inflation raises all prices, including rentals. Occupancy rates often surge when home production slows and demand for existing units rises. In such circumstances, landlords boost rents, generating more cash (and increasing property value) according to CoreLogic data, nationwide rentals jumped 10.2% year over year in September 2021.
Finally, fixed-rate mortgage payments do not fluctuate over time, i.e., payments remain constant while equity growth accelerates. Inflation also lowers the value of money owed in the future.
Advisors and investors should be mindful, however, that as mortgage rates rise during inflationary periods, demand for real estate tends to fall as debt becomes more expensive. The consequent drop in demand may have a detrimental influence on asset prices.
“Despite uncertainty from the omicron variant and other hazards,” CBRE research predicted in December 2021, “a growing economy will fuel demand for space and increase real estate investment across all building types.”
Inflation in the United States reached multidecade highs in 2021, owing to strong economic growth, labor shortages, and stifled supply chains. Nonetheless, interest rates will not rise enough to hurt real estate markets, according to CBRE, with the 10-year Treasury yield expected to touch 2.3 percent by the end of 2022. (up from 1.4 percent in early December).
However, the real estate picture for next year remains optimistic. In instance, multifamily investment volume in the United States is predicted to approach $234 billion in 2022, up 10% from 2021, indicating that the market is still recovering.
To summarize, in a volatile global market, privately held, high-quality real estate with predictable income streams can be an excellent allocation option. Real estate has long been praised by advisers and investors for its capacity to weather inflationary pressures while keeping and growing value, in addition to providing relatively high yields, moderate volatility, and various portfolio diversification benefits.
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 it wise to purchase a home during an inflationary period?
Inflation is at 7.5 percent, while housing values have increased by 20% year over year. Supply, interest rates, and inflation are driving today’s fast rising house prices. Even if the prices are high now, buying now can save you money in the long term.
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 real estate an inflation hedge?
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.
What happens if inflation continues to rise?
Inflation raises your cost of living over time. Inflation can be harmful to the economy if it is high enough. Price increases could be a sign of a fast-growing economy. Demand for products and services is fueled by people buying more than they need to avoid tomorrow’s rising prices.
What increases as inflation rises?
“Because TIPS are indexed to inflation, they can help balance out your fixed income or bond portfolio,” explains Diahann Lassus, a CFP and managing principal of Peapack Private Wealth Management.
TIPS are one of the safest investments you can make because they’re backed by the US government. They’re also a good method to diversify your portfolio while augmenting potential retirement income.
TIPS help protect against these unanticipated jumps in inflation because their price moves in lockstep with the Consumer Price Index (a measure of consumer prices paid over time), according to Amy Arnott, a portfolio manager at Morningstar. She told Select, “TIPS are by far the finest inflation hedge for the typical investor.”
TIPS bonds pay a fixed rate of interest twice a year and are available in 5-, 10-, and 30-year maturities. Investors are paid either the adjusted principle or the original principal at maturity, whichever is greater.
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.
What is the safest investment?
Cash, Treasury bonds, money market funds, and gold are all examples of safe assets. Risk-free assets, such as sovereign debt instruments issued by governments of industrialized countries, are the safest assets.