Rising inflation reduces the purchasing power of the dollar. Investing in real estate is one way to hedge against rampant inflation.
December 2021 marked a four decade high for inflation. It hit 7%, making it the fastest rise since the Reagan administration. This means that your dollar today won’t hold the same amount of purchasing power as it once did at other times. It also creates a consistent rise of prices for goods, services, and just about anything that we spend money on.
While inflation sounds dreadful, it could be good or bad based on the current economic circumstances. The Federal Reserve changes interest rates as a tool when it’s too high or too low. Although monetary policy may change at any time, there’s a strong suspicion that interest rates will rise multiple times in 2022 to combat inflation.
Investors know that rising inflation cuts into the value of their dollar. However, certain asset classes provide a greater sense of security than others. The top three hedges are gold, commodities, and real estate. These, especially real estate, are important to understand during this period of wild inflation.
Gold is known as one of the most traditional hedges. It’s a physical asset that historically holds value even though it doesn’t have a yield. As a precious metal, gold holds value better than silver, platinum, and palladium.
When the economy is struggling and inflation concerns are on the rise, investors don’t shy away from gold. Some investors bought gold at low purchasing points when the economy was in a lower inflationary period. Now that inflation is on the rise, gold has the potential to hold its value better than the dollar. Diversification is the advantage with gold because it’s valued by most of the countries around the world.
A commodity is a raw material or agricultural product that is traded in bulk. They are owned by the companies that make them and can be sold to consumers. While there are all types of commodities on the market, here’s a few examples:
Commodities are traded on the futures market. Given the complexity of any type of investment, it’s best to consult with professionals. However, once you have an understanding of how futures work, they are a powerful hedge against inflation.
When we see a rise in inflation around the 1% to 2% range, commodities are likely skyrocketing. Even a small rise in inflation may cause commodities to trade higher.
While a person might not need gold in their everyday lives, many commodities are daily necessities. Some recent examples are the cost of goods at grocery stores and the lumber shortage that plagued the country not so long ago. In essence, commodities are practical goods that people use in their daily lives out of necessity.
The real estate market has been buzzing over the last few years. While Americans are shelling out more money for the same amount of food and gasoline, they are spending more on homes, too.
Investors are aggressively pursuing real estate as a hedge against inflation. This, plus competition from those pursuing homeownership is driving up the cost of real estate. Year over year, home prices on average rose 19.8%. But why is real estate such a great hedge?
Leveraging is one strategy real estate investors use, borrowing money to purchase property. Borrowing, instead of covering the full price of the home up front in cash, is a powerful tool. Someone can put 20% down on a property and benefit from all of the potential upside.
Interest rates, though rising at present, were at historic lows at points throughout 2021. As a result, those who bought property have lower monthly payments locked in. For buy and hold investors, this means that as rent prices increase over time, the landlord’s monthly rate remains the same.
Real estate income
Income from monthly rent checks does hedge against inflation. During rising periods of inflation, demand for real estate also increases. Both large and small investors rush to diversify their portfolios with real estate. Landlords can charge more for rent as the price of housing in general increases, allowing them to keep up with or surpass inflation.
Since rent prices tend to increase over time, it keeps a good pace with the costs of inflation. The demand for rent has been increasing over the past year as housing expenses continue to grow. There’s also the advantage of selling a rental property while the prices are sky high for maximized profit. Finding a great deal and holding the rental property until inflation is higher makes real estate a fantastic hedge.
REITs or real estate investment trusts, are companies that own a range of property sectors such as office space, malls, and apartment buildings. These companies lease out space and generate income which is then passed to shareholders. The public including Wall Street could invest in a REIT just like they would invest in a stock. An estimated 145 million American households live in homes invested in REITs, just to put in perspective how common they are.
Currently the housing market is going through periods of sharp rent increases and demand on top of inflation. The extra rent income is helping investors hedge against inflation.
Real estate is the ultimate inflation hedge
Real estate and certain other asset classes perform well compared to inflation. As the value of the dollar decreases, investors around the country are flocking to buy real estate.
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Rob Marini is a content writer for Sundae who also produces content for real estate agents, investors, and prop tech companies across the country. He works as a digital marketing specialist in Connecticut, where he resides. When he’s not designing content or learning about real estate, you can find him podcasting, playing the guitar, or watching the Philadelphia Eagles.