Real Estate and Inflation: Is Real Estate an Inflation Hedge?
One of the biggest current news stories in the United States - and globally - is inflation. From Fed rate hikes to increases in household goods and services prices, inflation is hitting us all hard. Inflation has also triggered fears of a recession, leading to mass layoffs in previously booming industries like tech.
In this economy, your first instinct might be to go into austerity mode, spending as little as possible to ensure your financial stability. But it is a great time to invest in real estate if you can afford to do so. As opposed to stocks, bonds, and other retirement funds, investing in real estate can make inflation work for you, allowing you to increase your income as inflation rises.
At Eaton Realty, we understand that real estate can be a great investment in a tough economic climate, particularly over the long term. We represent both buyers and sellers of real estate in Hillsborough County, Florida, and offer property management services for landlords. If you’re interested in a more secure investment in the Tampa-St. Petersburg region, give us a call to learn more about our services.
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Inflation is commonly described as a decrease in the purchasing power of a dollar. The easiest way to view the effects of inflation is often over time; something might have cost 25 cents in 1960 but costs close to $2 now. In recent months, however, inflation has rapidly increased. Large increases in prices over a series of months have given us an even closer look at how inflation affects our daily lives. For example, just a few weeks ago, we learned that the price of Halloween candy had risen by 13% since 2021.
A combination of factors usually causes inflation. Our current inflation is primarily related to the effects of the COVID-19 pandemic due to supply chain issues that affected both production and delivery. The war in Ukraine has also contributed significantly to global inflation. Other factors that lead to inflation include supply and demand, fiscal policy, manufacturing costs, and corporate policy.
A certain amount of inflation is expected. Typically, a 2% inflation rate is considered healthy. However, as of October 2022, inflation had risen to 7.7%. The Federal Reserve has taken steps to combat inflation by raising the interest rate; the theory behind these rate hikes is that when it is more expensive to borrow money, consumer demand cools, and inflation slows.
When inflation rates are higher than the average return on investment and salary increases, Americans lose purchasing power. Even if your investment accounts are earning money, you can buy less with that money. Many financial experts believe that real estate is an effective way to hedge against the long-term effects of inflation.
How Real Estate Can Serve as a Hedge Against Inflation
The reason why real estate is considered a solid investment and a hedge against inflation is relatively simple. Over the long term, most real estate increases in value regardless of what the economy does. Even when real estate prices collapse (as they did during the Great Recession of 2008 - 2009), they tend to recover over time. Unlike stocks and bonds, the prices of which can fluctuate significantly based on the economy, real estate is typically a solid, stable investment.
When you have a fixed-interest-rate mortgage, the cost of your mortgage will remain the same even as interest rates increase due to inflation. This means that your equity in the home will increase while your costs to own the house are roughly the same.
A fixed-rate mortgage will also cost less over time. With this type of mortgage, your monthly payment is based on the dollar's value at the time of purchase. As inflation rises, you are effectively paying with “cheaper” dollars.
An example can help to illustrate how this works. If your mortgage payment is $1,500 per month, in today’s dollars, that $1,500 may buy 300 gallons of milk. In 20 years, your mortgage payment will still be $1,500, but because of inflation, that same amount of money may only buy 75 gallons of milk. During that period, your wages will likely increase, so $1,500 will be easier to pay.
If you have investment properties, renting out these homes can be very profitable. This is particularly true for properties with high turnover, such as multi-family dwellings. You can raise the rental price while your mortgage payments stay the same, which allows you to generate additional income to balance the rising inflation rate. Alternatively, if your lease agreements allow for it, you can increase the rent for long-term tenants at the end of the lease term.
The price of rent tends to increase with inflation. Across the United States, the average rent has risen by as much as 30% from 2021 to 2022. In Tampa, average rental prices have increased by 20.5% over the past year - far beyond inflation. While taxes and insurance may also increase due to inflation, landlords still see increased profits due to the ability to raise rent prices.
The bottom line: buying real estate for yourself or as an investment can be a way to protect yourself financially. Even as inflation increases, the cost to own the property will stay the same with a fixed-price mortgage. At the same time, your equity in the property will increase.
What to Know About Investing in Real Estate While Inflation Is High
Real estate can be a hedge against inflation - but that isn’t always the case. If you buy when interest rates are incredibly high (as they currently are) or do not have a fixed-price mortgage, then it may actually be a poor financial decision to buy real estate as an inflation hedge.
You should consider other factors as well. Increases in rental prices and the value of real estate are based in part on supply and demand trends. Buying real estate as an inflation hedge may backfire unless you plan to hold onto the property long-term to ride out these trends.
Consider what is happening with short-term rentals. Many people bought rental properties during the pandemic to rent them out through sites like Airbnb. As demand for these properties has cratered (in part due to Airbnb rentals often being more expensive for guests than hotels), many are sitting empty. In this situation, supply and demand trends may mean that people who bought properties to rent them out through Airbnb are actually losing money, even though inflation is high.
As with any investment, it is crucial to think carefully about your financial status and risk tolerance before buying real estate. A seasoned real estate company in Hillsborough County, Florida can help you make a smart decision based on your unique circumstances.
Looking for a Home or Investment Property in Hillsborough County? We Can Help
The real estate market is very different than it was one year ago. Nevertheless, investing in real estate is still a smart choice for many people. Whether you are buying a home for yourself or as an investment property, Eaton Realty can help.
Based in Lithia, we work with buyers, sellers, and landlords. We have years of experience in the Tampa housing market, which we use to help our clients make the best possible real estate investment. To learn more, fill out our online contact form or call our office at 813-672-8022.