Recently, there have been many conversations surrounding the current inflation. What does it mean for real estate investors in the US?

Table of Contents

  1. What Is Inflation?
  2. What Causes Inflation?
  3. How Does Inflation Impact Real Estate Investors?
  4. How Does Inflation Impact the Real Estate Prices?
  5. What Should Real Estate Investors Do During Inflation Periods?
  6. What’s Next for Real Estate Investors?
  7. Key Takeaways

For the longest time, real estate has been recommended as a hedge against inflation. If you’ve invested in the real estate market lately, you’ve probably experienced the forces of inflation. 

Since no one can say they’re quite certain about the future, it’s important for you to understand inflation, how it works, how it affects your real estate investments, and the best ways to protect yourself.

In today’s article, we seek to look at the inflation definition and delve deeper into the topic.

What Is Inflation?

Inflation refers to the rise in goods and services prices in a certain economy over a particular period, mostly over a year. For instance, the average rate of inflation annually is 1.8%. Assuming you bought an electric cooker last year for $400, you’d need to pay an additional $7.20 for the same cooker today.

It might not seem like a lot of money to be worried about. However, when you add all your bills, including internet, gas, groceries, phone bills, and other expenses, you end up spending a lot more money annually. 

A country feels an even bigger impact when it experiences above-average inflation. For example, in the past decade, the inflation in Greece almost hit 5%. It means that the $400 cooker above would cost an additional $20 today.

You can also look at inflation as the decrease in the purchasing power of the currency over time. For example, since 1913, the US dollar’s purchasing power has declined by roughly 96.5%. If you had $1 a century ago, it would only be worth about 3.50 cents today.

Since inflation causes a dollar to buy less over time, you now understand why you need to pay more for your milk, gas, and even rent than you did a few years ago.

Some people confuse inflation with appreciation. The two are different. Appreciation in real estate refers to the rate at which a property’s value goes up over time. The increase in value in appreciation isn’t due to inflation. The value appreciates due to the rise in demand.

It’s common to see the value of property increasing at a higher rate than inflation. It can also depreciate as the economy experiences inflation.

What Causes Inflation?

While it’s no secret that everything nowadays is becoming expensive, what actually causes inflation?

  • Lax monetary policy: This is also known as money printing. It increases the amount of money in circulation, which, in turn, results in the decline of the currency value. For example, the US government provided a $5 trillion stimulus during the pandemic. It unleashed the largest flood of money ever recorded in US inflation history. The amount was three times more than the approved financial aid during the Global Financial Crisis in 2008.
  • Supply Shocks: Supply shocks happen when there’s a rise in prices due to an increase in demand but a low supply. It happens when there are natural disasters or business lockdowns.
  • Demand Shocks: Demand shocks include when you find real estate investors engaging in bidding wars to purchase investment properties with the potential to yield rental income. 
  • Expecting prices to rise: According to the IMF, expectations of rising prices eventually become self-fulfilling. When business people expect the prices to rise, they adjust their prices. In such events, you find rent prices increasing or investors negotiating wages.

How Does Inflation Impact Real Estate Investors?

While inflation can look like a negative thing, it’s not entirely so. There are some positives to note. Let’s break down this section into what inflation means for homeowners, investors, and prospective investors. We’ll look at both positives and negatives.

Inflation for Homeowners

The positives of inflation are mainly enjoyed by homeowners. The most obvious perk is that the value of their homes appreciates with the inflation rate. It can be difficult to get a mortgage during inflation. Due to the high mortgage costs, many people continue to rent, hence driving up the demand for housing.

With high housing demand yet low supply, homeowners can demand higher prices. It’s common to see homeowners receive even higher offers than their asking prices. As you can tell, it makes inflationary periods an excellent time to sell but a hard time to buy.

Related: Where to Find Homeowner Information for Investing 

Inflation for Investors

Investors are another group who tend to experience some positives out of an inflationary market. Say you seek financing to invest in property as a leveraged asset with rates as low as they’re now. You’ll find yourself paying back the same rate while your property’s value rises. 

In the current inflation, the financing rates aren’t rising at the same rate as the inflation. It means that your return on investment can soar.

Inflation for Prospective Investors

Prospective investors tend to bear the brunt of an inflationary market. The circumstances are different from those for homeowners and existing investors. Inflationary times lead to high costs of borrowing. Since banks and lenders don’t want to lose their money, they offer fewer loans at high interest rates to reduce their risk. 

Inflationary times also lead to a high cost of building. Due to the high cost of borrowing and building materials, new constructions during inflationary periods can be a difficult investment. 

While you may want to invest in short-term rentals during an inflationary period, remember that during such times many people tend to cut their travel budgets. Since the vacation rental business is driven by tourism, it may not fare well in such times.

How Does Inflation Impact the Real Estate Prices?

In the past decade, the typical price of an average single-family home in the US has risen by over 90%. According to real estate experts, we can expect home prices to continue rising by 13.6% in the next year.

What causes the increase in home prices during inflation periods?

Demand in Income Generating Assets

One of the major reasons why home prices increase during inflation times is because real estate investors search for assets that will generate rental income above the current inflation rate.

Rental income is the money collected from the tenants and used to settle property expenses, such as property taxes and mortgages. Any money that remains after settling the expenses is the return on investment. We express the rate of return as the capitalization rate (cap rate).

During inflationary periods, investors will look for properties that offer a higher cap rate than other investment options, such as Treasury bonds or high-yield savings accounts.

Related: How to Find Properties That Promise High Rental Income 

Limited Real Estate Inventory

Real estate prices during inflationary periods also go up because of the limited amount of real estate compared to fiat currency. You’ll find governments printing more money during such periods to increase the money supply. It causes real estate prices to rise.

For instance, let’s assume that a country has $1 million in circulation and 100 homes are on sale. We’re assuming that there are no other goods or services on sale and that all homes on sale are identical. As such, each property would be worth $10,000.

Now, if the government prints an additional $1 million, there’s a total of $2 million in circulation.  It means the homes would now cost $20,000. As you can see, the printing of money is one of the factors that cause the rise in home prices and lead to inflation.

Increase in Home Construction Costs

Inflation causes all prices to increase, including land, wages, building materials, and supplies. As a result, home builders pass the cost of construction to home buyers and investors. It reflects in the current real estate market.

In the past 12 months, building material prices have risen by over 19%. Home construction materials include lumber, ready-mix concrete, and gypsum boards used for finishing ceilings and walls.

So, what’s the remedy for real estate investors during inflation?

What Should Real Estate Investors Do During Inflation Periods?

With all these factors in mind, the most important factor prospective investors must consider during inflationary periods is timing. Ask yourself one question; How long do you intend to own the prospective investment property?

If you want to keep it in the long term, you can expect to enjoy the same benefits as existing owners, such as property value appreciation. If you’re looking to invest in a shorter period, likely through a fix and flip strategy, we advise you to proceed with a lot of caution.

One major danger of investing in the short term during inflation is that you risk getting caught in the real estate bubble. Closing costs during such periods may rise up to 6% of the home selling price. As a new investor, if you don’t have enough equity to settle such costs, then you may lose a lot of money should the bubble burst.

This is where Mashvisor tools come in. While you can use an inflation calculator to calculate the inflation rate, you need our rental property calculator. The tool allows you to calculate a property’s expenses, as well as monthly rental income. Our rental property calculator also lets you see the property’s return on investment metrics, such as cap rate and cash on cash return, as well as the cash flow. Book your Mashvisor demo today and see how our tools can help you in your investment.

Recently, property prices have risen to historic levels. While the trend may not cause concern, it emphasizes the importance of understanding your investment time horizon and planning accordingly.

Inflation - Mashvisor's Rental Property Calculator

Mashvisor’s Rental Property Calculator allows investors to calculate a property’s monthly rental income and see the relevant return on investment metrics, such as cash flow, cash on cash return, and cap rate.

How Can Investors Use Investment Property as an Inflation Hedge?

Investing in real estate during inflationary periods always depends on the location and the state of the market. However, investors may use the following ways to gain a hedge against inflation:

  • Rental properties: Since many people can’t afford to build their own homes during inflation, rental properties, including commercial, residential, multi-family, and single-family units, tend to have a higher demand. As a real estate investor, you can then pass the cost of inflation to your tenants by charging higher rental rates. 
  • Real Estate Investment Trusts (REITs): Investing in a REIT allows investors to diversify their investment portfolios and access high dividend payments. Simply put, it’s a company that owns, finances, and operates real estate. REITs usually follow market demands and appreciate at the same rate as physical real estate. You can invest in REITs during inflation to spread your investments across diverse assets.
  • Leverage cheap money: Mortgage interest rates have reached historical lows. The current average is 3.07% for a 30-year mortgage with fixed rates. A real estate investor can take advantage of the low-interest-rate environment to steer clear of paying higher rates in the future.
  • Capitalize on rising asset values: History has demonstrated that real estate investors benefit from owning properties in the long term. For example, since 1990, median home prices have risen by 345%. Similarly, property prices have increased by nearly 20% since 2020. It is another reason to justify using real estate as a hedge against inflation.

It’s essential for you to have funds available so that you can seize any available opportunities. As we always advise, make sure you carry out your due diligence since investing during inflation periods can go either way.

Related: Direct Real Estate Investment vs. REITs

What’s Next for Real Estate Investors?

The bursting of the 2008 housing bubble and consecutive economic recession still haunts investors, buyers, and sellers to date. Please note that while prices continue to go up, it’s difficult to predict a market decline. There’s still not sufficient data to suggest that a recession is imminent.

For starters, the current market inflation is quite different from what we experienced just before the Global Financial Crisis. Though there’s a short supply of labor, the economy is growing at a steady rate, and the rate of unemployment is on a decline. We remain optimistic that the post-pandemic economy will fully reopen and grow to provide more opportunities.

If you want to make any major financial decision, always keep your guard up and do your due diligence. Smart planning and time management will help you manage your economic risk. Also, speak to your financial advisor and real estate agent so you can find the best place to buy rental property.

Key Takeaways

Real estate prices tend to increase during periods of inflation due to the excess money in circulation in the economy. Many investors have used real estate as a hedge against inflationary periods. You can use real estate to generate income above the inflation rate and also capitalize on the potential property value appreciation in the long term.

Most importantly, use Mashvisor tools in your investment. Sign up today and receive 15% off your quarterly or annual subscription fee.

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