If you’re abreast of the country’s economic state, you know we are amid raging inflation affecting every industry. With that in mind, it’s only reasonable that intending and existing property owners ask themselves some essential questions. This article seeks to explore and hopefully answer the question, “is it wise to invest in real estate during inflation?” We’ll do so by discussing what happens to your portfolio during an economic downturn and if rental properties work as a suitable hedge. Stick around if you want to understand why now might be the perfect time to secure financing for a rental.
What Happens to the Real Estate Market During Inflation
- Mortgage Rates Rise
One of the immediate effects of inflation is a rise in mortgage rates. When the economy is in a downturn, the central bank tries to encourage people to save more and keep their money in the banks. One of the most effective ways to do that is by increasing interest rates. The promise of higher returns discourages people from withdrawing and taking more expensive loans. Thus, with lower consumer consumption, inflation is more likely to fall.
This effect is a potential negative for homeowners as the cost of borrowing increases drastically.
- Asset Prices Increase
Another significant thing in the real estate market during inflation is that asset prices increase. Studies by Stanford University show that rental properties are more likely to outperform other investment classes during inflationary periods. Of course, that is partly due to rising mortgage rates pushing up the cost of building. Thus, there’s less competition for developers and homeowners who can continue construction or can afford a loan.
- Existing Debt Decreases
For existing property owners, inflation presents an excellent opportunity to pay off their debt. Since inflation reduces the value of money, paying the same amount after several years means the latter payments are cheaper. For example, let’s say you buy a house for $200,000 with a $40,000 downpayment at a 3% fixed interest rate. Assuming the loan term is 20 years, your monthly payment would be $1,085. If inflation increases by 2% yearly, your interest would decrease in value. However, you would save more money because you would be paying the same price for 20 years. Twenty years later, when you’ve entirely paid off your debt, your house would be worth more than $200,000. Thus, your relative mortgage repayments reduce in value every time inflation knocks.
- Construction Costs Increase
Inflation affects the cost of all products, including those for construction. Thus, developers would see a rise in material and labor costs. Since these production prices are often passed on to the consumer, property owners would experience an increase in housing prices. This price increase can force out many individuals looking to build and instead, they choose to rent for a year or two. So, rising construction costs, in turn, help to drive the demand in the rental housing industry.
- Rental Prices Rise
An increased demand, coupled with limited supply, means rent prices will also rise during periods of inflation. With higher mortgage rates and construction costs, landlords are also more likely to raise rent to recoup some of these added expenses. Thus, renters could find themselves with higher bills amid an economic downturn. Hence, it wouldn’t be surprising if property owners find it harder to collect rent from their occupants. However, using a professional property management service for rental collection makes the process much smoother and pain-free.
Can Real Estate be a Hedge Against Inflation?
Surging markets often create a flurry of panicked investors, worrying about the state of their portfolios. Considering inflation is at one of the highest it’s ever been in the last 40 years, we have to ask, ‘how does inflation impact investors and landlords?’ Well, for strategic investors, inflationary trends often mean good news. Over the last hundred years, with consistent value prices, real estate has proven itself as an effective hedge against inflation. Most times, it even outpaces surging prices, especially in developing neighborhoods. Rental property’s intrinsic ability to hedge inflation is partly thanks to the consistent demand for housing.
3 Reasons to Invest Now
1. Consistent Demand for Rentals
Despite rising costs, the demand for housing tends to remain consistent, especially in desirable neighborhoods. Thus, if the market for real estate remains, why shouldn’t investors meet those needs? Besides, since rental prices go up during inflation, it means landlords stand to make more money. However, this demand for rentals is often dependent on the type. Investors in SFUs, condos and multi-family units tend to fare better than the rest. On the other hand, vacation rental owners might experience a decline in demand thanks to the inflationary cycle.
2. Higher Returns
Another benefit of investing during inflation is earning higher returns on your asset. Historically, real estate tends to fare well during inflationary hikes, surpassing other investment opportunities. Although, it’s not hard to see why rental prices go up and existing debt diminishes during this period. Besides, since real estate is one of the few ventures that can hedge the worst effects of inflation, you can preserve your equity. In reality, your home value is even more likely to increase.
3. Devaluation of Debt
Finally, investing during inflation is an excellent idea because of the devaluation of debt. As we highlighted earlier, when inflation hits, purchasing power reduces. However, their monthly repayments remain the same for property owners paying off loans with fixed mortgage rates. In other words, as the years go by, their interest reduces. Although, it is crucial to note that this effect only applies to borrowers with fixed interest rates. Since variable mortgages tend to fluctuate with inflation, subscribers of these loans might find themselves paying more during an inflationary trend.
Most experts recommend investing in the housing market when it’s at its lowest so you can reap the rewards later. However, that begs the question, ‘is it wise to invest in real estate during inflation?’ While many investors consider such a venture risky, inflationary trends present a unique opportunity for property owners to gain. Thanks to the consistent demand for housing, asset value increase, and debt devaluation. Thus, the current economic trend might be an opportunity for you to save and earn more money.