Inflation and Real Estate Investment: What You Need to Know
The challenges and opportunities of investing in real estate during times of inflation
It’s 2023 and the global economy has never been more different yet similar to the past! Inflation is still not entirely under control despite some optimistic news from the Federal Reserve at the end of 2022. The US CPI or Consumer-Price Index, which measures inflation, touched 9% in June 2022 and dipped to 7% by November 2022, rumour has it that the US Fed is still eager to speed up this dip by increasing rates in February 2023 by 0.5%. Not just in the US, but this move by Central Banks is taking place all across Europe, Asia and South America (except for Japan). Now, let’s look at Real Estate during this environment of interest rate hikes and prevailing inflation environment.
The inflationary environment poses both challenges and opportunities for real estate investors. On the one hand, inflation puts pressure on tenant incomes, making them more likely to default on their rent payments, and forcing landlords to reduce rent levels. At the same time, higher inflation means higher returns. In the current environment of high inflation, smart investors will identify higher-yielding real estates opportunities, such as multi-family homes, apartment buildings, and commercial properties. Real estate investments in areas with high rental demand, such as cities with large numbers. Alternatively, Real Estate Investment Trusts (REITs) have begun to gain popularity around the world for retail investors as rent from its real estate projects is distributed proportionately to investors with yields ranging from 3% to 7% on average. REITs also have the added advantage of being relatively more liquid as they are listed on public stock exchanges.
Real estate is essential for your portfolio because it can provide long-term gains, a stable source of income, and potential tax advantages. However, real estate investing comes with risks, including market volatility, the potential for physical damage, and the possible lack of liquidity. It is essential to research the market carefully, as well as factors such as taxes, insurance, and legal issues, before investing in any property.
In simple terms, as inflation and asset prices have a positive relationship, higher inflation leads to an increase in real estate and commodity prices. Gold and real estate have been historically the best hedges against inflation and even more for real estate in hot markets such as London, Hong Kong, and New York. In the long run, real estate and commodities such as gold and silver can fetch you a CAGR of 8-12% in a 10-15 year window.
At this point in time what is important to understand is that the Central Banks are playing an active role in cooling down the booming markets of 2020-2021 with interest rate controls. This means that the demand side (individuals willing to buy real estate) are putting off property purchases as borrowing rates have increased substantially in the past year. Real estate will do well given that the inflationary pressure on the global economy is no easy mountain to climb. In the short run, real estate will be rather illiquid and not easy to sell without offering significant discounts.
Real estate investing, even on a very small scale, remains a tried and true means of building an individual's cash flow and wealth. - Robert Kiyosaki