Real estate is considered a hard asset, one of the many unique groups of investments with the power to hedge inflation. Hard assets like precious metals, commodities, natural resources, and real estate hold intrinsic value that enable these types of investment to hedge against rises in inflation. In the case of real estate, both land and any structures on it are naturally limited in supply and serve our basic need for shelter. While not all real estate property is of equal value, its rental price will not only likely to keep pace with inflation, but also preserve and increase its intrinsic value.
There are a few specific reasons why investing in real estate is inflation-proof. But first of all, what is inflation? Inflation is simply the rate at which the price of goods and services rises over a period of time. In this case, the rate of increase in the prices is substantial and within a short timespan affecting the increase in the volume of money and resulting in the loss of value of currency. So, practically, during inflation, a consumer loses purchasing power which affects the general cost of living. While inflation is a natural occurrence in the market economy, this event can lead to a downfall in economic growth.
Inflation can be a really scary event for consumers, but might create an opportunity to gain continuous profit for real estate investors. So how does real estate hedge against inflation?
Let’s look at how the housing market reacts to rising prices.
- Rising prices will increase the resale value of homes over time.
Real estate appreciation can offset inflation making it a highly effective hedge against rising prices. Another way to describe it is that property price increases more than the rate of inflation. That’s because a home isn’t a luxury, but a primary human necessity. Since inflation can help property prices appreciate over time, all the real estate price appreciation is doing is keeping the real value of your investment and protecting it from the devaluing effects of inflation
- The cost of borrowing will be higher.
Inflation devalues the currency, which forces most lenders to raise interest rates. If you take a loan to purchase a property, there’s a decent chance of having a higher but fixed loan rate. That’s why the cost of borrowing tends to be quite higher to cover the losses. While not getting favorable loan terms happens to both property buyers and real estate developers; it is worth noting that as your fixed rate payments will stay the same, an increase in interest rates will invariably result in higher property prices
- Rental rates will increase.
Rental properties are without doubt the most profitable asset during inflation and will generate high returns. The increase in rental rates is one of the most noticeable effects of inflation. As inflation and the cost of goods increase, so do wages. And as wages increase, so does the cost of rent. As a property owner, you’re able to increase rent to fall in line with inflation, which puts you in an ideal position in this type of economic climate.
What makes a Real Estate Investment such an Inflation-Proof Asset
Real estate is a unique hard asset among an already unique group of assets with the power to hedge inflation. It can produce cash flow now and in retirement. It has the ability to preserve value and earn income through rental payments while hedging inflation, which makes it an attractive asset for those seeking protection from inflation.
While Inflation seems inevitable given the ongoing economic situation, understanding how inflation affects the real estate market and how real estate investment can provide a reliable hedge against inflation means having leverage on better decision making. As an investor, you can plan for inflation by investing in common anti-inflation assets, like real estate investments, that tend to outperform the market and getting the best returns available during inflationary climate.