Heightened Inflation, rising interest rates, and trillions of stimulus dollars injected into the economy is affecting everyone as prices and labor costs rise in varying industries. So how does this impact someone who wants to invest in real estate?
Let’s start by quickly defining inflation as “a general increase in prices and fall in the purchasing value of money.” Everything from gas, food, to industrial products become more expensive and consumers can’t buy as much of it. A person who could once afford a house might be forced to rent instead.
Real estate is also directly correlated to low interest rates, which allow people to buy more, thus also causing a rise in house prices. So, with high inflation, everyday consumers are affected in what they can buy.
People who keep cash in a savings account are essentially losing money because of the effects of inflation. Typically, a savings account might generate 0.5% – 2% at best, but when you subtract the percentage of inflation, you end up with overall negative returns. So, an investor investing in a 7% deal is getting a better deal than the investor not investing at all.
As mentioned, the Fed stimulated the economy to encourage consumer purchases and is raising interest rates to combat inflation.
Here is an example of what that means to consumers: Let’s say Bob is shopping for a home, and the interest rate was 3.5%, which was going to make his payment $2155. Then interest rates rise to 4.5% and now his payment is $2432. Bob may no longer be able to afford the house payment with that $300 per month increase. So now Bob must look for a smaller house, or even rent.
Investors could also be impacted by increasing interest rates, depending on their business plans. For example, let’s say Mary has a lease contract with a tenant at a locked in rate for a 10-year lease. She also has a mortgage of $2000 per month at 4.5%, but it has a 5-year balloon on the mortgage that comes due at the end of 2022. This means she must renew her mortgage at a higher rate now. Thus, her monthly payment increases to $2500 per month. Now her expenses have increased, but she cannot raise rent on her tenant, which puts her investment underwater.
Real Estate Syndicators must make business plans with all of this in mind. Any project with short-term debt or non-fixed debt will be forced to use higher rates later if not locked in.
So, is now a good time to invest in real estate?
Absolutely! Let me explain why:
Investing in hard assets of value (real estate) protects against inflation
Investing in appreciating assets with returns counters inflationary negative returns
Rates are still incredibly low
Rental growth is increasing yearly and expected to continue
Home ownership is on the decline, meaning demand for rentals is rising
The currency has been devaluing steadily for the past 50 years. However, a broad retrospective look at real estate over the past 50 years shows that almost all asset classes have experienced dramatic resilience against inflation.
Three things get wiped out in inflation:
Purchasing power for those on fixed income
Savings get wiped out
Debt gets wiped out
Since real estate investors tend to use a high proportion of debt in their investments, they almost always end up being the beneficiary of inflation because those long-term loans get devalued disproportionately compared with all the other elements associated with real estate. Rents go up in price. Operating expenses go up in price. New Construction goes up in price. It’s the last item that causes existing real estate to rise in price. Since the loan on a property doesn’t go up due to inflation, the increase in price is always to the benefit of the equity holder. Therein lies the inflation hedge.
In summary, if you want to protect your capital and increase returns, investing in cash-flowing real estate syndications in growing markets with long-term fixed debt is the best plan during inflationary periods.
