If you follow the financial news, you might be more confused about the future of our economy than someone who watches nothing. Watch three analysts, and they’ll tell you three different things. One will tell you that we’re entering a period of steep inflation, and another will say it’s deflation. The third, meanwhile, will forecast stagflation.
From 2010 through 2020, inflation in the United States averaged 1.8%. That’s slightly lower than the historical average, and it has provided a period of reliable – if sometimes boring – growth. But then came the Covid-19 pandemic. In two years, we saw a combination of supply chain shortages, business closures, and massive injections of stimulus money.
Now that things have – mostly – returned to normal, there’s a lot of debate about what’s going on. It’s undeniable that prices have gone up over the past year, but the outlook is less clear. Are these short-term aftershocks that will soon fade away? Or are we entering a period of sustained price instability?
Nobody has a crystal ball, but one thing is certain: you need to be prepared. This means understanding how real estate inflation works, how it can affect your investments, and how you can hedge against it.
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What Is Inflation?
Inflation is the rate of price increase for goods and services within the economy. It’s typically measured annually, although some metrics provide quarterly or even monthly increases. To put it another way, it measures how much value a dollar loses over time.
Here’s a simple example. Let’s say you bought a $500 dishwasher in 2010. At a 1.8% inflation rate, the same dishwasher would cost you $509 in 2011. That might not sound like a huge increase. But keep in mind that the effect is cumulative, much like interest. In 2020, that same dishwasher would cost $597.65. That’s a significant increase!
Now imagine an annual inflation rate of 5%. That’s what Greece experienced during its financial crisis, and it’s easy to see how it could put a dent in your wallet.
Note that inflation is not the same as appreciation. When your real estate investments experience inflation, you’re not really getting any benefit. The dollar value may be higher, but the real-world value has remained the same.
Appreciation, on the other hand, is driven by demand. The more demand there is, the more a given investment will be worth. If all is going well, your rate of appreciation will exceed the rate of inflation. In other words, your home value will increase in real terms. If your rate of appreciation is slower than inflation, your property will depreciate in value.
How Does Inflation Affect Real Estate?
Inflation doesn’t have to be a bad thing. If you’re a savvy investor, it can be beneficial. During times of high inflation, it can be more challenging for people to qualify for a mortgage. People who are saving up for a down payment may find themselves suddenly priced out of the market. And with higher interest rates, mortgages can become prohibitively expensive for some would-be buyers.
As a result, more people stay in the rental market, and rental prices increase. If you’re a landlord, you can cash in on that increase. Invest in some rental properties, and you can earn a significant profit during inflationary periods.
That said, there are also some pitfalls. Banks raise their interest rates during high inflation to offset their losses. They also tighten their lending terms, making it harder to buy a property to begin with. In other words, prospective landlords suffer from the same roadblocks as prospective homebuyers. So the time to benefit from high inflation is beforehand when loans are still affordable.
In addition, not all rentals benefit from high inflation. While home rentals stand to gain, vacation rentals tend to suffer. Travel is one of the first things people cut from their budget when money gets tight.
Real Estate Investments For An Inflationary Economy
So, where should you be investing your money during an inflationary economy? Here are some of the real estate investments that perform the best:
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Apartments and single-family homes – these will go up in value.
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Mortgage note investing – banks will be offloading notes at discount rates.
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Real estate investment trusts (REITs) – make sure they don’t invest in vacation rentals.
Remember that investing in real estate can be more expensive in inflationary times. It’s critical to have the cash on hand to take advantage of opportunities as they arise. Otherwise, you could get priced out of the market.
Summary
Real estate inflation can be bad news for would-be homebuyers or the ill-prepared. But if you know what to expect, you can put yourself in a position to succeed. And if you already own rental properties, you’ll be even better positioned to benefit.
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