How inflation affects real estate investors

How Inflation Affects Real Estate Investors

Inflation has already started affecting panic across the country, and that causes real estate investors to ask a lot of questions. For example, “What is the effect of inflation on property value?” When inflation goes up, consumer prices across the board, increase. So let’s look at what happens to real estate investments — not just real estate value.

For the most part, as inflation rises, it takes with it things like mortgage rates, acquisition costs, construction costs. But all those increases can actually benefit a savvy real estate investor and if you position yourself correctly, you can thrive in a high-inflation environment.

How Investors Benefit From Higher Mortgage Rates

When inflation goes up, eventually interest and mortgage rates do as well. This is because central banks try to combat inflation by raising rates, and they do that to slow consumer spending. When interest rates go up, consumers tend to save more and be more selective on what they buy. When interest rates are low, consumers tend to borrow and spend more.

So when we’re in an inflationary environment, we can expect to see higher mortgage rates — and fewer home buyers. Of course, when you see the effects of inflation on property value, it’s also a good time to look at REOs.

The Effect of Inflation on Property Value

So when inflation starts really driving costs up, and we’re talking across the board, right? Cost of materials, cost of logistics, everything is going up and to the consumer, ultimately, the cost of buying a widget at Walmart, is higher than it was last year, right?

When that happens to widgets at Walmart, it also starts to happen to real estate. Inflation goes up, housing goes up — BUT, at the point of critical mass, there will be an opposing force, called rising mortgage rates, that actually peaks out as the demand decreases.

How Inflation Eats Debt

So now let’s look at how inflation can actually lessen the impact of your historical debt. Let me paint a picture.

Let’s say 5 years ago, you bought a rental property and after your down payment, you were carrying a mortgage of $100,000, ok?

You’ve got a 25-year mortgage on $100,000 at a 3% fixed interest rate.

If inflation rises 3% every year, you’re still only making that $475 payment, right? But at the same time, the value of the money you’ve already paid, has gone up by 3% every year. Since that money is already ‘in the bank’ you’re essentially locked in and every year inflation goes up, you’re actually making money because the relative cost of your debt goes down.

Then There’s Construction Costs

Effect of inflation on property value tends to bring new construction to a hault

When things get more expensive for the consumer, that means wages go up, materials and logistics go up because fuel prices go up, right? I know we’ve been working on a large real estate development here in Albuquerque, that most of the preliminary design work and budgeting has been done over a period of 3 years, and that means that we have to occasionally adjust our budget to account for inflation and the rising cost of materials and labor. If you don’t make those adjustments, it puts you in a position as an investor, where you’ll likely run into cost-overruns.

Residential Investing Beats Everything Else During Inflation

But here’s the good news. If you’ve got single-family homes, apartments, duplexes…those asset classes while be very likely to outperform other investments. To understand the effect of inflation on property value, we need to analyze historical data.

Stanford did a study, I’ll link to it here, that shows residential real estate is a safe-haven during inflation. What they found was that home prices went up relative to the size of the economy.

What that means is, investments in real estate perform better, than investments in stocks and bonds — during a time of rapid inflation. Since residential rents (and even office and retail space) are tied to the economy, when inflation rises, so do those rents. Higher rents means more profit because with a fixed-rate mortgage, your monthly payments aren’t going up.

And since the cost of construction is also going up, you don’t have to worry so much about new apartment complexes cropping up.

Speaking of Rent

OK, so here’s an important caveat — you’ve got to keep rents inline with inflation. If you don’t raise the rent to mirror inflation, you could lose money. If inflation rises 3% and you don’t raise rents, you’re taking a hit.

That doesn’t mean you have to stick to the exact inflation rate, but historically, average annual rental rates have increased by 8.5%.

Is Real Estate a Hedge Against Inflation?

So since inflationary environments typically lead to higher rents and higher asset prices, real estate is a great hedge against inflation. Think about the three key traits that we observe during inflationary periods:

  1. As inflation goes up, so do rents
  2. As inflation goes up, so do property values
  3. Your debt of your asset is devalued (since inflation is higher, the relative cost of your debt is less)

In order to know how inflation

What you want to watch for though, is borrowing during high-inflationary periods. If you get in too late, you’re not reaping the real estate-related benefits of inflation, you’re just along for the ride.

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