Inflation has become one of the dominant worries of investors in recent months. Data repeatedly shows that inflation has been steadily increasing and is now hovering around 7% per year, a number not seen since 1982, 40 years ago. If inflation keeps going at this level, any idling cash you have will be worth 7% less next year than it is right now. It comes as no surprise then that investors worldwide are frantically searching for investments and methods for how to hedge against inflation.
While all investments involve some risk of loss, and the proverbial past performance is no guarantee of future return applies, some assets have been pretty good hedges when it comes to inflation. Many people cite gold as a hedge, but owning gold has disadvantages. Looking at the data, real estate is arguably the best hedge for inflation, and here’s how.
How to Hedge Against Inflation: Why Is This Topic So Critical?
Before getting into why real estate is the top way to avoid some of the pain associated with inflation, it’s vital to understand why investors must be extra careful with investments during this inflationary period.
When you invest, you’re likely doing so for a goal. You want to invest to have a comfortable retirement, or maybe you’re putting money into your child’s 529 hoping to give them a debt-free experience in college. Goals are as essential to any investment strategy.
The problem for investors is that during periods of high inflation, you may think that you are getting closer to those goals when you are actually getting further away from them. Investing during these periods often produces mirages where returns that were once stellar during regular times are no longer good enough.
Fortunately, the math is quite simple and easily illustratable with an example.
Suppose inflation is 2% per year, and you are saving for college for your child. College now costs $10,000 per year. In 10 years, at 2% per year, the college tuition will cost $12,189.94.
Further, suppose you have a $10,000 investment growing at 5% per year. At the end of those five years, you’ll have $16,288.95, which will pay for your child’s tuition and give them an extra $4,099.01 for supplies!
Now, let’s say inflation is 7% per year. That means the college tuition bill will now be $19,671.51. But, your investment only has $16,288.95 in it! Even though you have been earning 5% on it, you’ve been losing in real purchasing power. You would need an investment making 7%+ per year to afford college under this scenario!
If you don’t pay attention and choose investments that rise at or above inflation, you’ll be further away from your goals as time elapses!
Why Is Real Estate Such a Hedge for Inflation?
Given how essential it is to find investments that beat inflation, you might be wondering how to hedge against inflation. The answer is quite simple (at least from a historical perspective): buy real estate!
Real estate has always been an excellent hedge against inflation for income, reduced relative debt payments, and increased property values.
It’s no secret that real estate produces monthly passive income in rent. One of the key driving factors of almost any inflationary period is housing costs. With the cost of living rising and people spending more, one of the first things to increase is rent.
If you have a building with a short-term lease structure that can react quickly and pivot to these higher rents.
There’s no guarantee that the company will raise dividends to match inflation with stock ownership! Or, you may have purchased bonds back when 4% was beating inflation, and now that good investment has suddenly turned negative. With real estate, you almost always have the chance to renegotiate and bump leases (especially in commercial and multi-family settings!) to match inflation!
Reduced Relative Debt Payments: A Key for How to Hedge Against Inflation
As the income from your unit is going up, your mortgage payment (relatively speaking) is getting smaller each month.
Most mortgages now have a 3% interest rate or lower. If inflation is rising by 7%, that means, fundamentally, your mortgage is getting 4% cheaper per year on your building!
So, your rents rise to match inflation, but your mortgage interest rate underperforms inflation. This results in more money in your pocket and less money (over time) in the banks!
Increased Property Values
On top of the two benefits above, there’s a third – property values almost always rise in lockstep with inflation. Recall how rents usually go up. Property prices almost always rise, too.
During the last high-inflation period in the 1980s, single-family home property prices rose from $47,200 in 1980 to $79,100 in 1990. That increase in value roughly corresponds with the inflation occurring during that decade. 1980 saw 13.5% inflation, but by the mid-1980s, it was down to about 2% per year.
How to Hedge Against Inflation: Invest in Real Estate
Real estate is the only asset where, in theory, your income can rise with inflation, and your most significant expenses (the mortgage) can become cheaper over time. During these periods of higher inflation, in theory, you could only pay 3% to borrow money to have an asset that will appreciate 7% in value and has income that appreciates 7% annually, tracking inflation.
There are very few other asset classes that do this. Stock prices may or may not track inflation. Additionally, the volatility of the Stock Market during inflationary periods can have a devastating impact on your investments.
The bond market is often slow to react to inflation. New bond issues may be at higher rates, but certainly, any old bonds you have could now be in the negative. And while gold tends to go up in value during inflationary periods, it does not have the unique advantage of having debt that becomes cheaper while revenue keeps increasing.
If you want the best hedge against inflation, real estate is almost always the way!
Now, you may be wondering how to get involved in real estate with no experience or time to manage the stress of finding deals, arranging a loan, managing tenants, and being responsible for the maintenance issues of owning a real estate property! Lucky for you, real estate syndications provide the solution for everyday investors to invest passively in large commercial real estate deals that will hedge their hard-earned capital against inflation!
At Disrupt Equity, a commercial real estate acquisition company, we offer a ton of free written and video content helping you learn more about how to get started investing in a real estate syndication with an acquisition company, along with the pros and cons of doing so. Please check out the below for further resources:
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