Investment assets can be intimidating, especially with long-term commitments. Inflation can be difficult to assess, and it can reduce a promising option to financial losses. If the inflation rate outgrows your assets’ value, your net worth takes a hit.
Commercial real estate has always been recommended for investors looking to outpace inflation. For many experts, real estate is a fantastic opportunity regardless of interest rates. However, the reason goes somewhat beyond that belief.
Today, we’ll find out why real estate is so effective against inflation. If you’re interested in investing in this market, you might want to hire professional financial services to evaluate your options.
Let’s talk about inflation hedge
Real estate is essentially an inflation hedge. That means an investment asset that can protect investors against losing their purchasing power. Inflation hedges are assets whose value remains or increases over time regardless of inflation.
Gold is another outstanding inflation hedge, but real estate offers unique advantages. Many investors also leverage stocks for this goal, yet this strategy can be counterproductive depending on the market.
Additionally, investors can use inflation hedging for more than protecting their capital. Operational costs can benefit from this method.
Why do companies care?
Primarily, companies can protect their investments' value with inflation hedging. Stable assets enable companies to increase value in the long term. Properties' market value and rental income are famous for rising during inflation.
However, companies' operational expenses are likely to increase with inflationary periods. Hedging offsets this obstacle. Inflation causes companies to raise their prices or cut costs to maintain their margins. Inflation hedging reduces this need.
How effective is real estate as an inflation hedge?
Many studies have measured why real estate can be an efficient investment strategy against inflation. Its appreciation and stable demand despite financial complications makes it a good bet for many investors.
We need to also consider different property types and their performance. The retail property seems to be the most effective inflation hedge, and industrial and apartment markets come in second place. Unfortunately, office real estate's property income falls short, but property values remain promising.
Considering interest rates
Inflation isn't the only factor we need to measure, as interest rates play a close role. We need to consider income growth, primarily compared to interest rates. Income usually doesn't grow as much as inflation.
Additionally, adding interest rate increases, cap rates will likely remain high. If that’s the case, real estate asset appreciation will become a challenge. The problem is that yield-only returns lose value with inflation if investors only break even.
How can we calculate real estate’s efficiency as an inflation hedge?
Real estate offers unique advantages as an inflation hedge. It allows investors to gain a new income stream from their inflation hedge, which isn’t possible with gold and similar assets. Even if this income loses value, it’s merely an addition to your property’s worth.
Additionally, the real estate market can be easier to access for individual investors. This is unlike more extensive stocks, which are usually restricted to Wall Street firms and hedge funds.
Leveraging low-interest rates
Real estate performs more proficient for inflation hedging when interest rates are low—the lower, the better. However, that doesn't mean that real estate's hedging suffers when interest rates aren't expected, as it's rare for cap rates to decrease.
Interestingly, that makes real estate one of the best investments amid COVID-19 since cap rates are at an all-time low. Economic growth also boosts the market’s effectiveness for hedging.
Significant developments
We also have to consider government debt and how the government tackles it. Most experts think about increasing taxes or reducing social benefits. However, the latter is considerably harmful given the current pandemic.
However, reducing interest rates is the ideal approach for real estate inflation hedging when combating government debt. It naturally causes inflation to rise to attempt to increment nominal GDP. If that's the case, properties become the best hedging asset.
Real estate’s adaptation to inflation: Analyzing the dynamic
But why does this relationship exist? How can real estate offset inflation, and what's the difference between its interaction with the market and other assets? Inflation increases prices in the market, and that means increasing production costs as well.
Many sectors feel inflation’s brunt, but real estate often comes out unscratched. Additionally, real estate is easier for investors than other markets. They can work with REITs, crowdfunding platforms, private equities, and mutual funds.
Property appreciation
Property prices increase with inflation. Construction materials increase, boosting the price for new real estate developments, and older properties usually follow this trend.
This appreciation allows investors to considerably curb inflation, enabling them to sell their investments for a higher price. Interestingly, US inflation has been significantly lower than appreciation, protecting investors' net worth from inflation.
Borrowing costs
Additionally, price hikes make loaning a terrible investment. People can repay loans quickly, but the amounts will be worth much less. Therefore, loan terms become noticeably less favorable when inflation is an issue.
Interest rates for loans usually increase to offset this value decrease, looking to cover losses. Buyers and developers in the real estate market feel the effect of this development. People typically rely on loans for investing in properties, and most construction firms require loans to carry their projects.
Rental rates
Lacking purchasing power, people will gravitate toward renting since it’s more affordable. That increases rental rates, and this makes rental properties a fantastic investment during inflation.
Overall, rental properties generate better returns as inflation grows. The inability to purchase properties enables property managers to charge more for their rent.
Does real estate benefit from inflation?
It would be inaccurate to say that any market or industry benefits from inflation. Even the wealthiest investors need to cope with hiking costs. That's why real estate as an inflation hedge - it helps you curb this damage.
Nevertheless, real estate is the best investment for many companies and individual investors when inflation becomes an issue. It offers all the features and advantages necessary to overcome it.
Streamline your Real Estate Operations
Assetsoft helps you streamline your real estate business for more productivity. We help you optimize your work processes and choose the right ERP. Know how using the right technology can benefit you, from using robotic process automation to back-office accounting. Contact us today!