Is Real Estate an Inflation Hedge?

Inflation due to all the stimulus money out there has been a hot topic. It's commonly understood that real estate is a hedge against inflation. But, why is it a hedge, and what does that mean. We try to put this in layman's terms because we aren't economists either. In this article, we will explain what inflation is and how real estate is a hedge against it.

 What is Inflation?

 “Inflation is the decline of purchasing power of a given currency over time. A quantitative estimate of the rate at which the decline in purchasing power occurs can be reflected in the increase of an average price level of a basket of selected goods and services in an economy over some time. The rise in the general level of prices often expressed as a percentage, means that a unit of currency effectively buys less than it did in prior periods." -Investopedia

The consumer price index (CPI) is the most common form of measure for our economy. It's a calculation of the average price changes of pre-determined basket goods and services. Anywhere from what you're buying at the grocery store to gas you are putting in your tank. There is a considerable concern of increased inflation due to the rapid increase of the money supply, which could turn into rapid price level increases. We are already seeing hints of this occurring at unusual levels. 

 What does inflation mean for real estate? 

 There are three significant places inflation hits real estate rents, prices, and expenses.  

 1.      Rents

 As the cost of goods goes up, so do the most significant expenses most people have with housing. However, there are other essential factors like supply and demand. As wages inflate, people have more available cash to spend on rents, which helps boost those prices. Usually, rents keep in line or do better than inflation. In the OKC market, it's tended to beat inflation overall. As the increase of these rents increases, so does the value of the property. At times other inflationary factors can affect specific pockets if they are in the path of progress. In this case, things becoming more expensive is a good thing because we take that much more rents.

 2.      Prices

 Obviously, with the rents increasing, so do the price and value of the property. We can capitalize on this by either selling or performing a refinance. We prefer to refinance option because usually, after-tax you can take out just much as in the sale. Then these proceeds can be used to invest in new inflation hedging assets. Values are affected by cap rates which can be affected by interest rates and other sales in the area. In general, values/prices rise in line and usually better than rent increases. 

 3.      Expenses

 This expense factor is less talked about. Of course, with all goods and services increasing in price, so do expenses for the property. For example, landscaping or utility rates can go up. However, things like utility rates tend to change a lot slower. We usually see rent increases outpacing any of these expense increases. One expense that doesn't change is our fixed mortgage. As inflation diminishes the dollar's value, it so eats away at the principal in the loan. A good fixed-rate mortgage has enormous implications when it comes to hedging against inflation. It's always prudent to keep a close eye on increases in expenses as you actively operate the asset. 

Apartment investing is not a complete hedge against inflation but has always withstood the test of time and the ebbs and flows of the economy. This is a huge reason why the long-term hold makes so much sense due to the natural inflationary factors of our markets. If you have a good asset in a good location and operate well, the inflationary factors will reward you.