3 Ways Inflation Could Affect Your Real Estate Investments
Real estate investments are often considered safe, because historically they have consistently gained value over time. However, mortgage and interest rates are climbing at a rate that is unprecedented, with the consumer price index (CPI) rising to 8.5% – the highest since 1981.
So, how can inflation affect your real estate investments and what can investors anticipate through the end of the year in the current market?
In this blog, you will learn:
What inflation is and which key factors investors need to watch out for
The impact of inflation on mortgage and interest rates in 2022
The key benefits of real estate investment in times of economic downturn
Keep reading to learn what you as a real estate investor need to keep in mind before exploring buying or selling. Smart investing starts with staying informed and the team at UD+P strives to empower investors with the information they need to create long-term portfolio growth.
Learn more about investing with UD+P on our Investors Page.
What is inflation?
Inflation can be defined as the overall decrease in purchasing power of money. Goods and services cost more, and every dollar earned or saved loses value. While there are many ways to measure inflation, the most common is the CPI which shows changes over time in the prices paid by consumers in an average month.
How does inflation impact the market for investors?
It has been a long time since investors have really considered inflation as a threat to their portfolios. In 2021, there was much debate about what caused this bout of inflation and whether it is temporary or permanent.
The usual thinking is that trillions of dollars of federal stimulus have flooded the market with currency, thereby causing deflation in the value of the dollar and long-term inflation in prices. However, supply-chain effects may be the dominant culprit. If so, the disruption in prices may be temporary (although it may persist over the span of a couple of years).
While different asset classes react uniquely to these circumstances, real estate investments often continue to perform well–particularly income-generating properties and multi-family homes.
What is the outlook for real estate investments in 2022 and beyond?
Mortgage rates for owner-occupied homes are at a recent high with 30-year terms hovering at 5.3% (and growing), making new purchases harder to finance.
Throughout 2022, the team at UD+P has observed investors feeling more uncertain about new ventures as they anticipate rising interest rates, or they seek discounted pricing on the property to account for higher interest rates.
To protect against losing the buying power of savings due to inflation, investors must identify assets that track inflation well. In other words, we want investments that rise in value along with inflation. This means these assets should be highly correlated in their pricing. Ideally, such investments will also provide a return above the rate of inflation.
Historically, there has been a very tight correlation between urban residential real estate rent (or equivalent rent for homeowners) and core inflation in urban areas. With a correlation coefficient of .91 (1 being a perfect positive correlation, 0 being uncorrelated), the cost of urban residential rent (and owner equivalent rent) correlates almost perfectly with inflation, as the following graph of BLS data shows:
.91 Correlation Coefficient Between Urban Shelter and CPI chart. Source: The US Bureau of Labor Statistics.
This means that rents generally rise with CPI, counteracting the power of inflation to deflate asset values.
While the US economy may be facing challenges at the moment, there is little reason to expect an imminent crash in the commercial real estate market. In fact, multi-family real estate is performing very well for our investors, and across the country. Shorter term investments may carry more risk, but projects like UD+P’s have proven earning potential and virtually none of the risk. The market is bound to fluctuate, but the key to real estate success is longevity.
Wondering if your investments are diversified and resilient? Contact us to schedule a meeting with our investment team to discuss current offerings.