Although high inflation is viewed as a time of instability, history shows us that it’s a time for investors to seek new opportunities, specifically in real estate, and that investing in real estate could be one of the best ways to hedge against inflation.
The Consumer Price Index (CPI) measures inflation and sits at around 3% in early 2025. While this is significantly lower than the 9.1% spike in June 2022, it’s above the Federal Reserve’s 2% goal.
Current and prospective real estate investors need an understanding of what these numbers mean to make informed financial decisions. This article will cover the additional need-to-know factors affecting real estate and inflation, including property value appreciation, rental income, and fixed-rate mortgage benefits.
Understanding Inflation and Its Impact on Investments
Inflation is the average price increase for a collection of services and goods over a set period. As overall prices rise, purchasing power declines.
In the past, high inflation rates have been a sign of economic instability. Asset classes like stocks, bonds, and cash can be inflation-sensitive. These investment methods may see their values decrease as inflation erodes purchasing power. However, many investors seek new investment options during inflation, specifically in real estate.
It’s best to turn to the past to understand the full impact of inflation. In the 1970s, many investors saw a clear trend—while stocks and public market assets declined, the housing market saw a boom.
Unlike intangible investments such as stocks or crypto, housing is a basic human need and is near the end of the list of unnecessary expenses. When comparing stocks versus real estate, investing in property can be a reliable hedge against inflation and can add tangible value to an investment portfolio.
Why Real Estate is Considered a Hedge Against Inflation
While other investment vehicles may be more susceptible to the effects of rising prices, real estate tends to exhibit relative stability during inflationary periods. This is due to factors such as increased demand for housing and the ability of landlords to adjust rental rates to reflect rising costs.
Property Appreciation
It’s essential to distinguish between inflation and appreciation. In real estate, appreciation refers to the increase in a property’s value over time, driven by demand rather than changes in currency value. A home’s appreciation rate can outpace inflation, but it can also decline even in an inflationary economy.
While appreciation is a separate market factor, housing prices generally tend to rise during periods of inflation. According to the U.S. Census Bureau, from 1975 to 1981, U.S. inflation averaged over 9%, and home prices also saw a substantial increase. Property values nearly doubled during this time, rising by approximately 90%.
Rental Income Growth
In a rental market with a sufficient number of available properties, the rent increases and decreases tend to follow inflation rates. Factors like a growing population and a finite rental supply can increase rents beyond the inflation rate. Landlords can increase rents to keep pace with inflation and respond to market conditions.
However, to fully capitalize on rising prices, property owners focused on stability and profitability might consider strategies that involve more frequent rent adjustments. For example, leases that are regularly ‘marked to market’ (i.e., adjusted to current market rates upon renewal) allow property owners to capture increased rental income during inflationary periods. While long-term leases with built-in escalation clauses offer some protection, they may not fully reflect the potential for rent increases during significant inflation.
Fixed-Rate Mortgage Advantage
Typically, the housing market is even more affected than the rental market by rising inflation. The Federal Reserve often responds to inflation spikes by raising interest rates. One way that borrowers can avoid future effects of high interest rates is by locking in a fixed-rate mortgage during an inflation lull.
Locking in a 30-year mortgage at 3% versus 6% can drastically change your monthly mortgage payments. During inflationary periods, mortgage debt, especially fixed-rate mortgages, tends to be more favorable than other debt types. This is because inflation reduces the real value of debt over time, a phenomenon known as the Fisher effect.
Fixed-rate mortgage holders are insulated from rate hikes and benefit even more from inflation-driven debt devaluation. Other forms of debt, such as credit cards and personal loans, typically become more expensive during inflationary periods. These debts often carry higher interest rates that adjust upward in response to Federal Reserve policies, increasing borrowing costs without the same long-term benefit of reduced real debt value.
Commercial vs. Residential Real Estate During Inflation
Inflation impacts commercial and residential real estate slightly differently, but both tend to offer a degree of protection against inflationary pressures. Commercial properties such as office buildings, retail spaces, and industrial properties can benefit from long-term leases and triple-net leases (NNN). In NNN leases, tenants cover property expenses like taxes, insurance, and maintenance, helping protect landlords from rising costs.
Interestingly, office buildings may be negatively affected during times of decreasing inflation since low inflation rates correlate with higher unemployment. For residential real estate investors, single-family and multifamily properties both benefit from rising rental demand during inflation.
When considering how to invest in real estate to potentially hedge against inflation, it’s important to compare different investment approaches, such as direct real estate ownership and Real Estate Investment Trusts (REITs).
REITs, for instance, can offer investors a relatively liquid way to participate in real estate’s potential to protect against inflation. This is because REITs invest in income-producing properties, and rental income and property values often tend to rise during inflationary periods. However, it’s important to note that publicly traded REITs offer greater liquidity compared to direct property ownership, as they are traded on stock exchanges.
Over the past 20 years, REIT dividends have outpaced inflation in all but two years, as measured by the Consumer Price Index (CPI). REITs give investors exposure to multiple sectors and the benefit of professional management. Meanwhile, direct ownership is more limited, though, for hands-on investors, full control can be attractive. The rising housing costs and price growth can also make high inflation a good time for direct owners to sell.
Whether pursuing direct real estate ownership or considering another approach, these strategies have historically performed well during inflationary periods, making them valuable options depending on an investor’s goals and risk tolerance.
Risks and Challenges of Real Estate During Inflation
Real estate is not immune to risks. There is plenty of data on how markets tend to perform during inflation, but unexpected changes happen. Additionally, rising interest rates, increased taxes, and potential liquidity challenges are concerns for investors.
Since inflation often leads to higher interest rates, financing may be more expensive, which is a serious challenge for direct ownership investors. During times of high and low inflation, maintenance costs are always an expense. Increased inflation-related property expenses can make it even more difficult to keep up with maintenance and taxes.
Certain types of REITs can be traded similarly to stocks and bonds, but other real estate investments have limited liquidity compared to stocks and bonds. This may make it more challenging to quickly sell property during times of favorable inflation rates.
Strategies for Investing in Real Estate During Inflation
Use these strategies to make intelligent real estate investments during high inflation.
- Diversification: Consider investing across property types and markets to mitigate risk.
- Leveraging Debt Wisely: Taking advantage of fixed-rate mortgages can help to minimize borrowing costs.
- Value-Add Properties: Improve properties to increase income potential and hedge against inflation.
- Exploring REITs and Alternative Investments: Investors seeking potential passive income and a degree of inflation protection may consider options such as REITs and Delaware Statutory Trusts (DSTs). DSTs allow investors to co-invest in properties to benefit from potential passive income without being responsible for management.
Invest in Real Estate to Preserve Wealth During Inflation
Investing in real estate can serve as a hedge against inflation while adding value to your portfolio. While real estate can offer protection, strategic investing is essential to maximize benefits.
At 1031 Crowdfunding, our team has over 135 years of combined real estate experience. Explore a range of tax-advantaged real estate investment opportunities. Register for a free investor account with 1031 Crowdfunding to access exclusive listings and connect with our 1031 exchange specialists
This material does not constitute an offer to sell or a solicitation of an offer to buy any security. An offer can only be made by a prospectus that contains more complete information on risks, management fees and other expenses. This literature must be accompanied by, and read in conjunction with, a prospectus or private placement memorandum to fully understand the implications and risks of the offering of securities to which it relates. As with all investing, investing in private placements is speculative in nature and involves a degree of risk, including loss of your principal. Past performance is not necessarily indicative of future results and forward-looking statements and projections are not guaranteed to achieve the results described and your actual returns may vary significantly. Investments in private placements are illiquid in nature and there may be no secondary market or ability to sell the investment should the need for liquidity arise. This material should not be construed as tax advice and you should consult with your tax advisor as individual tax situations will vary. Securities offered through Capulent, LLC Member FINRA, SIPC.
