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If you’ve watched the news lately, you’ve likely heard about the risks of inflation. It’s coming at us at a much higher speed than normal as the economy and business world work their way out of the pandemic state they were in for over a year.
In many markets, inflation is as high as 5%, which is an unprecedented rate compared to the past few decades. Fortunately, you can use real estate to hedge against inflation.
Here’s how.
Understanding Inflation
Inflation is a decrease in your purchasing power. The dollar becomes worth less than it was yesterday, which means it takes more money to buy the same products, assets, or investments.
It happens when there’s more money available (stimulus money) and a higher demand for products and services. When people are willing to pay more for things, it drives up prices and drives down the value of the dollar.
As prices increase, the value of the dollar decreases, which can make even the best investments worth much less than before.
Inflation Predictions for 2022
Experts so far believe we’ve seen the worst of inflation as of the last quarter of 2021. As you might have seen, gas prices decreased slightly in December which was the first sign of good things to come.
Experts believe we won’t see an increase in inflationary rates that hit almost 7% in 2021 in 2022. It will take a while for the economy to settle down again, but as supply increases and demand settles, inflationary rates will slow down too.
However, this doesn’t mean you’ll see prices fall. The higher prices we’ve had to adjust to quickly are here to stay. Some higher prices won’t affect you as much, like a gallon of milk or a carton of strawberries. Even if they cost 20% more than before, it won’t cause you to go bankrupt.
Where it can affect people the most, though, is in larger assets, like real estate. If a home costs 20% more than last year and it originally cost $200,000, you’re looking at a price of $240,000 this year – that’s a difference of $40,000.
That being said, real estate can be a great way to hedge against inflation, so it’s important to position yourself so you can buy real estate and possibly avoid other inflationary-prone assets.
Why you Should Worry about Inflation
Inflation is always an issue, even when we aren’t in periods of high inflation like right now. Each year, the Fed predicts an inflationary rate of at least 2%. Again, that doesn’t sound like much, especially when you’re talking about low-ticket items.
But over time, that inflationary rate cuts your purchase power by the double digits. A 3% inflationary rate, for example, can almost cut your purchasing power in half in the next 40 – 50 years.
So, it’s not something you have to lose sleep over tonight because it will affect your ability to buy groceries tomorrow, but it is a concern that you should keep at the forefront of your mind as you consider your investment options.
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Is Real Estate Inflation Real in 2022?
You probably wonder will the inflationary rates continue to affect real estate in 2022? With the crazy increase in prices and values over the last year, it can’t last forever, right?
While we might see real estate values settle slightly, there are still many reasons experts believe values and prices will continue to soar.
Millennials can Finally Enter the Market
Millennials have been at a disadvantage for years. They entered adulthood just as the housing market crashed and they watched millions of people lose money. Most millennials held off from investing in real estate and instead rented.
Fast forward to today, millennials are turning around 33 years old and are ready to settle down and buy real estate. This means millions of people are going to want in on real estate this year which will keep driving prices higher.
This means there will continue to be a higher demand for real estate and most people believe this will go on for at least 5 years.
Supply Chain Issues are Still a Problem
Supply chain issues have affected everything from the food you buy at the grocery store to the materials used to build homes and it’s not going to fix itself overnight.
A smaller supply of materials means fewer homes built and higher prices to make up for the cost of materials. Unfortunately, there doesn’t seem to be an end in sight as one of the largest producers of steel (Beijing) put its production on hold to limit pollution during the Winter Olympics.
As if supply issues weren’t enough, there is still a labor shortage too. With fewer people to build homes, builders can build as fast as they used to. This means demand will likely continue to outpace supply, keeping prices high.
Is Real Estate a Good Hedge Against Inflation?
If you’re looking for a good hedge against inflation, you might wonder if your stock portfolio is good or bad.
Unfortunately, there’s not a straight answer because it depends on many variables. However, growth stocks tend to perform poorly during periods of inflation, whereas value stocks perform better. But there’s really no way to predict how stocks will perform.
Real estate, on the other hand, has a positive history during periods of inflation. But how do you hedge against inflation using real estate? It helps to understand how real estate hedges against inflation first.
How Real Estate Hedges Against Inflation
Your primary residence may or may not hedge against inflation, but any investment properties you have might just do the trick.
Here’s why.
Investment Properties Earn Rent
If you own investment properties and rent them out, you receive monthly income. If you have short-term leases, you can increase the price of rent annually or whenever you turn over a new lease.
This helps you keep pace with inflation since it’s a natural increase. If you had a non-appreciating asset or one you couldn’t increase your earnings on, it wouldn’t hedge against inflation because your earnings would be worth less than before.
Home Prices Rise during Inflation
Typically, home prices increase during inflation. This means it costs more to buy a house, which is bad if you’re in the market to buy, but good if you own a property.
Higher sales prices mean higher home values. A higher value means a lower loan-to-value ratio. For example, if you owed $100,000 on your home that was worth $200,000 last year, but your home is now worth $210,000 this year, your LTV fell from 50% to 47.6%. You have more equity in the home. If you were to sell it today, you’d make more money than last year.
Debt Depreciates during Inflation
If you have financing on the property, your mortgage payment won’t change (if you have a fixed-rate loan) but you’ll earn more income from the higher rent. This keeps your earnings up and your debts down. Your mortgage payment won’t increase or change during inflationary periods, but the amount you can earn from the property might.
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4 Ways to Use Real Estate to Hedge Against Inflation
Fortunately, there are many ways to use real estate to hedge against inflation. Here are the top ways.
Buy a Multi-Unit Property
While any investment property can be a good hedge against inflation, multi-unit properties provide even more protection.
When you own more than one unit, you have more opportunities to raise the rent, increasing your earnings. Again, if you keep short-term leases, your properties will turn over more frequently, giving you the option to increase rents. Even if you get the same tenants renewing the lease, if you have the provision in the lease to increase the rent, you can increase your earnings.
Buy Land
If you don’t want to invest in properties themselves, consider investing in land, especially farmland. Since land is limited, the opportunities to make money on land you own are endless.
Like real estate, land appreciates. If you just hold onto it and sell it for a profit, you can hedge against inflation by making more on the property than you paid for it. But, if you want to increase your chances of hedging against inflation, consider renting farmland to farmers. You get annual cash income from the crops the farmer plants and sells plus monthly rent if you charge rent for land use.
When you sell the property, you also earn the profits from the land appreciating, especially if you sell during a period of inflation.
Passively Invest in Real Estate
If investing in real estate directly doesn’t entice you, consider passively investing in real estate with real estate crowdfunding.
You can invest in a property’s debt (be the lender) or equity (earn dividends from the income). Like regular crowdfunding, you invest in the property with other investors, so you own a small portion of the property, not the entire thing.
The nice thing about REITs is you don’t have to deal with the property itself. You have no responsibilities to manage it, sell it, or maintain it, but you earn the profits from investing in real estate.
Refinance your Current Loans
If you have an adjustable-rate loan, it pays to refinance it before or at the start of inflationary periods. Inflation usually means higher interest rates, which can negatively affect your mortgage payment on an ARM loan.
To hedge against inflation, refinance out of your ARM into a fixed-rate loan. If you, do it before the inflationary period is predicted, you’ll get the lowest rates, but if not, the sooner you refinance the better.
You also have some control over the rates you get. The better situation you pose to the lender (high credit scores, low debt ratios, and stable employment), the better rates they can offer.
Diversify your Portfolio to Hedge Against Inflation
Like any investment, it’s always a good idea to diversify. We aren’t saying to only invest in real estate and forget everything else.
Putting all your eggs in one basket is never a good idea. Instead, spread your money throughout various assets. This gives you a chance to earn money in some sectors when others aren’t doing so well and vice versa.
You won’t find two sectors that react the same way to politics, the economy, or other outside factors, but when you diversify your investments, you make the best of it.
A portfolio heavy in stocks, for example, is at the mercy of the stock market. If it crashes, like it did during the pandemic, you lose most of what you have. But, if you diversified and had money in stocks, bonds, and real estate or other hard assets, you would likely ride out the storm at a much more even pace.
Whether you’re ready to invest in a multi-unit property, land or you just want to get your feet wet with a real estate investment trust, add real estate to your portfolio to hedge against inflation.
Final Thoughts
Always be thinking about how to stay two steps ahead of inflation. 2022 will be another year of inflationary prices and the more you prepare yourself, the better you’ll come out of it financially speaking.
If you’re ready to explore your options to invest in real estate, let’s connect. Our experienced loan officers can help you find the perfect loan to help you hedge against inflation. You don’t need a lot of money to invest in real estate today. With 20% – 30% down, you can leverage your investment, diversify your portfolio, and come out ahead of inflation.
