3 Types of Real Estate Investment to Hedge Against Inflation
The current inflation rate in the U.S. is around 7.5%, this is the highest it has been in over 30 years. Regardless of your profession, if you earn and spend money in U.S. dollars, inflation is having an impact on you.
Experts don’t see a reduction of inflation anytime soon. Fortunately, there are ways to minimize the strain it puts on your finances and an investment in real estate could be an ideal hedge against its impact.
Continue reading to better understand inflation, how it impacts you, and how investing in real estate could help.
WHAT IS INFLATION AND HOW DOES IT IMPACT ME?
Inflation is defined by a general increase in the price of goods and services and the decline in the value of money. This means it becomes more expensive to purchase a product because the cost to create that product has gotten more expensive, which simultaneously means the dollar you use to purchase the products buys a little bit less over time.
The standard measurement of inflation is the consumer price index, or CPI. While a little bit of inflation is considered normal and healthy for an economy, the 7.5% rate of inflation that the CPI measured at the start of 2022 for the previous year is high.
What are some of the impacts of inflation on your life?
Reduced Purchasing Power
We touched on this briefly, but as prices rise, you won’t be able to afford as much for the same income. This may limit your budget or savings due to the increased prices or require you to purchase fewer goods and services.
Higher Costs to Borrow
The federal government will usually attempt to curb the amount of inflation. They do this by having the Federal Reserve raise the federal funds rate. This in turn leads to higher interest rates on things like credit cards, car loans, and mortgage rates.
Lower Standard of Living
The increase in the costs of goods and services when inflation is high tends to outpace the increase in wages. Because of this life is less affordable for everyone but particularly hurts individuals on a fixed income like retirees.
Your Savings is Eroding
For the last decade plus interest rates on savings account have been close to 0%. If you’ve had money sitting in a savings or checking account it cannot purchase as much as it did 10 years ago. When inflation is high the damage done to money held in savings escalates.
We mentioned that interest rates are expected to rise; however, it’s unlikely interest rates on savings will keep pace with inflation. While this may seem like a doom and gloom scenario there are ways you can mitigate the effects of inflation by finding smart places to invest your money outside of banks.
A PROVEN HEDGE AGAINST INFLATION
If not banks where is a good place to invest your money to preserve its value and protected from rising inflation? There are a handful of investments most advisors have historically recommended:
Stock and Mutual Funds
Many people will invest in the stock market or mutual funds as their primary hedge against inflation. However, high inflation periods can also be volatile for the stock market as the past few months have shown.
Commodities
Tangible assets, also known as commodities, like oil, precious metals and minerals also become popular during times of inflation. Theoretically the price of commodities should climb along the price of other goods and services when inflation hits. The most common choice in commodities is gold and unfortunately data shows that it hasn’t risen consistently during times of inflation dating back to the 1970s.
Inflation-Indexed Bonds
TIPS or Treasure Inflation Protected Securities, are government-issued bonds that indexed to inflation. Meaning they rise at the same rate as inflation. While bonds are low risk, they also offer little in returns other than fighting off the effects of inflation. For short-term, liquid investments they can be a safe thing to consider but they are not going to grow your investments.
Real Estate
Historically real estate prices have risen alongside inflation, in many instances it even outpaces the rise of inflation. This leads to an increased demand in real estate which pushes prices even higher and is one of the reason prices on real estate are currently soaring.
In the past year in Austin home prices have increase by over 30% while nationally they have rose 17%, 10% more than the 7% rate of inflation. Additionally, some real estate investments allow you to generate a stream of passive income through rental income. For real estate investors they avoided inflation decreasing their purchasing power through their investment.
3 Types of Real Estate Investments
While there are countless types of real estate investments to choose from, there are three common investments that are recommended for the majority of investors.
Primary Residence
If you are already a home owner, you’re ahead of the game. The traditional advantages of homeownership are expounded when inflation is high. When prices rise due to inflation, the value of your home has historically risen as well. Additionally, your locked into a monthly housing payment for the next 30 years which makes you immune to the rising cost to rent.
A homeownership goal can be a worthwhile pursuit if you don’t currently own your primary residence. The first objective is understanding how much you qualify for and saving or having enough for the down payment and closing costs. While this may seem daunting in the current market connecting with a real estate advisor or mortgage loan officer can let you know where you stand as well as help you craft a strategy that will help you reach your goals.
Regardless if you currently own your primary residence, it is also a great time to consider an investment property. The majority of real estate investments fall into two categories, long-term and short-term rentals.
Traditional Long-Term Rentals
Traditionally rental properties have been single family or multi-unit dwellings where you rent out to a single tenant for over a year or longer. These tenants also furnish the property themselves and pay for services to maintain the property such as utilities and regular maintenance.
For long-term rental tenants the home functions as their primary residence which means it’s a necessary expense and therefore a stable source of income for the property owner.
When considering investing in a traditional long-term rental, it’s important to budget for certain expenses. Property taxes, homeowners’ insurance and HOA dues are going to be regular expenses as the property own. In most cases larger maintenance and repair expenses like replacement of an A/C unit will also be the responsibility of the home owner.
Vacation Short-Term Rentals
Short-term or vacation rentals, like AirBnB and VRBO, provide temporary accommodations and function more like hotels. While long-term rentals are typically a year technically short-term rentals are classified as anything rented for 30 days or less. Due to the nature of vacation rentals you’re going to need to furnish the property as well as provide other amenities.
The potential to earn more is greater with vacation rentals; however, this comes with the added cost of daily/weekly management, cleaning and marketing of the property. Not only are you becoming a real estate investor with a short-term rental but you will also need to be involved in the hospitality business.
Vacations rental when managed properly can offer the same hedge against inflation as traditional rentals with the added benefit of being a spot you and your family can vacation when the home isn’t being rented.
INVESTED IN HELPING YOU
Inflation is simply a fact of life currently. Fortunately, you can take action by carefully reviewing and managing your financial situation to help limit the effects of inflation on your finances. If you own a primary residence, you’ve already made a strategic decision that is helping you in the current financial environment.
If you are ready to invest in real estate or need more guidance that reading an article reach out to a trusted real estate advisor who can advise you on your unique situation to help you meet your financial goals.
The above references an opinion and is for informational purposes only. It is not intended to be financial advice. Consult the appropriate professionals for advice regarding your individual needs.