Inflation has created fear, uncertainty, and doubt for investors and consumers alike as it has followed a steady upward trajectory over the past couple of years. Some speculate the current paywall is in response to disruptions caused by the COVID-19 pandemic. Others have pointed out that more money printed by the Federal Reserve and Federal spending and entitlement programs used to keep the economy afloat have been the underlying cause of recent surges of goods and services.
For investors, it’s ultimately about knowing when to adjust the sails — not only to weather the storm but to time the most optimal gust of wind forward. During this current wave, knowing how to assess risk and manage it is a fundamental skill for investors to hedge their portfolios against inflation.
Part of that assessment means determining if inflation presents an enigmatic or advantageous situation when it comes to investing in or managing real estate assets. This blog will cover what investors need to know about how inflation affects real estate and what needs to be considered to make savvy risk-management decisions.
What Happens To Real Estate During Inflation?
Is there a correlative relationship between real estate and inflation? Generally speaking, interest rates rise in tandem with inflation. Initially, lower interest rates may be created to promote consumer spending by creating conditions for more disposable income. As a result, inflation is likely to increase.
To combat these effects, central banks will typically increase short-term rates when inflation rises to exert downward pressure on the inflationary environment. Increased rates discourage consumers from spending, triggering a more appealing savings mode. So how do interest rates affect real estate during inflation?
As a byproduct, inflation can lead to higher home prices and creates an environment in the real estate market that usually sees higher mortgage rates and fewer buyers. The effect is overall positive for investors who already own assets in real estate or have a real estate IRA. As inflation rises, the cost of existing debt decreases.
Think about it this way — you invest in a real estate property prior to a period of inflation with a 30-year, fixed-rate mortgage locked in at 3%. As of August 2022, inflation in the U.S. was recorded at just over 8.5%. You will still be paying the negotiated locked-in interest you agreed upon before inflation’s incremental increase. Relatively speaking, the overall value of your money has increased. Each time there is an inflationary wave, the relative cost of your debt decreases.
Is Real Estate A Good Investment During Inflation?
It's said that a rising tide raises all ships. That's sort of true, save for the ships that are ill-equipped. For real estate investors, inflation should give no cause for concern. On the contrary, as illustrated above, investors are more likely to benefit from the relative decrease in debt. It's unfortunate but not surprising that those who are likely to suffer, or struggle are people who fall on the lower end of the economic spectrum. Those in debt or with property equity that isn’t well positioned are likely to feel a much heavier burden.
Note that property owners and real estate investors are not synonymous. For instance, a residential property owner may own a property that isn’t generating any cash flow, making it a lazy equity property. Alternatively, a rental property that generates cash flow for the owner counts as a producing asset because it creates a stream of income. These are some ways real estate investors can benefit from owning property compared to other investments in an increasing inflationary environment.
Furthermore, inflation drives up the price of goods and service, including building and construction materials. Wages, machinery costs, and building materials all go up under inflation. Developers and investors are then put into a bind where cost overruns are more likely to happen. For investors, that means accounting for how inflation will impact the cost of all the building materials and labor.
Like other asset classes, investing in real estate is essentially all about timing. If you didn’t catch your wave this go-round, set yourself up to be ready for the next one.
Is Inflation Good for Real Estate in my IRA?
If you have real estate in your IRA, you are more than likely to benefit from this long-term investment. Holding real estate in your IRA is one way to hedge against the, sometimes extreme, variability typically seen in the stock market.
As mentioned earlier, the high inflation effect on real estate markets will impact purchasing power. Due to the higher interest rates to buy, more people will have to rent. This in turn, raises rents which can mean more rental income in your IRA.
Housing prices may also be another benefit for real estate IRA investors— more properties will sit on the market longer due to high interest rates. This not only creates an opportunity for your IRA to be a lender, but it can also be opportunities to negotiate investments for your IRA.
Another effect of inflation may be higher unemployment. This also means people not being able to pay their mortgage, forcing them to sell their homes due to loss of employment— creating more renters for your real estate IRA.
How Can IRAR Help?
Investors who purchase real estate through a self-directed IRA (SDIRA) are responsible for conducting their own due diligence when it comes to choosing how to direct their own investments.
As SDIRA custodians, part of IRAR’s mission for more than 30 years has been to help investors navigate the market arena by providing them with financial tools and resources to get the most leverage out of their investments. We want to make sure you are getting the most out of your self-directed, tax-advantaged retirement account by building wealth through alternative investments at a lower cost.
Find out more about how we empower investors like yourself to strategically formulate a smarter, more affordable plan for your retirement savings. Book a free consultation with one of our experts today to take the reigns in advancing your future financial independence.