Money just isn’t what it used to be; literally.
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Inflation is running at multi-decade highs in the US. Coupled with heavy interest rate hikes from the Federal Reserve, the current storm of market events is shaking many investment portfolios. But there is refuge.
Smart investors know you can’t control the weather, but you can adjust the sails.
Here is why investors choose multifamily real estate in times of high inflation.
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Inflation is the decrease in purchasing power because the cost of products and services that you buy goes up.
Consumer prices were up +9.1% over the year to June 2022, the largest increase in 40 years.
While there have been signs of relief in July 2022 with a net-zero change in inflation due to a sharp drop in gasoline prices, other costs such as food continued to rise.
Ouch. How did we get here?
Inflation has been driven by a huge amount of money printing from the Federal Reserve in response to Covid.
The M2 money supply (cash, checking deposits etc.) has increased from $300bn in 1959 to $21.7 trillion. That's crazy – but what's worse?
$5.6 trillion of this has been created since March 2020 thanks to stimulus checks, bond buying, and pumping a ton of money into the economy.
The other driver of inflation has been the disruption in supply chains.
Covid saw rapid changes in demand for different goods and services.
This was then coupled with government measures to protect the health of their people, which even today continues to hamper a lot of supply chains.
If that wasn’t enough. A ship also got jammed in the Suez Canal, blocking a major gateway for trade.
The supply chain got derailed and so it takes more force to get it cranking again.
The end result – inflation is running hot and your dollars are losing purchasing power. How long will it persist?
It took us almost two years during Covid to reach the current inflation levels and supply chain disruptions, so it's not unrealistic to imagine it will take another two years for things to normalize (i.e. late 2024).
The US supply chain stress tracker – which looks at things like the number of cargo ships waiting to unload in LA, production costs and inventory levels – has fallen for three straight months. Unfortunately, it’s still well above pre-pandemic levels.
During inflationary periods like today, cash and bonds generally lose value.
Stock market returns can be mixed and will continue to be incredibly volatile. But real estate has proven itself over centuries to hedge against rising inflation.
Asset types that have cash flows that can adjust quickly in the face of rising inflation are called “inflation resilient.” This is what multifamily real estate provides as they have shorter lease terms so landlords can reset those rental rates to the new normal much faster than a five-year office lease.
The shorter the lease term, the faster you can charge new rents commensurate with inflation. Hotels typically provide the most flexibility as they can adjust prices daily, while office leases are typically 5- 7 years.
The takeaway is that income-producing properties can make inflation work for you.
Real estate has repeatedly proved itself as a hedge against inflation over the long term.
Below is research from Goldman Sachs that shows how rent growth has performed against inflation since 1995.
Landlords continue to show their ability to raise rents, particularly in markets with low vacancy rates where supply is constrained.
Outside of rising rents, mortgage debt in real estate can also provide additional benefits in inflationary environments.
Due to the high stability and durability that real estate provides, most commercial real estate is partially funded through fixed or floating rate debt.
In an inflationary environment, it’s important to note that more leverage and fixed rate debt create better real returns for equity investors in real estate.
With fixed-rate mortgages, loan payments stay the same. This creates a ‘spread’ between rising rents and the fixed cost of your mortgage payment.
You’re basically paying back with ‘cheaper dollars’ as inflation (and subsequent rents) rise.
When it comes to your financial future, considering the effects of inflation on your assets and how you can take advantage of the current inflationary environment is key.
Smart investors that adjust their sails can benefit from real estate’s inflation hedge characteristics.
Those sitting on cash will see their purchasing power drained.
Like any investment, commercial real estate is not risk-free. In times of inflation or economic distress, tenants may have more difficulty making payments and vacancy rates may increase.
Ensuring that you do your due diligence and invest alongside experts is of utmost importance.
By investing in income-generating real estate, you can hedge your bets against inflation and grow your wealth through the storm.