Investors have a lot to consider when they weigh the pros and cons of their investment choices – and that includes real estate assets.
Real estate investing has a reputation for being an asset that steadily increases in value over time. In fact, historically, real estate has indeed reliably risen in value year over year, with a few exceptions, including the housing market collapse that began in 2006. That makes investing in real estate a reliable investment choice for many long-term investors.
Here, we’ll review the key points you should know about the definition of inflation, what causes inflation and how real estate investments tend to perform during inflation. Along with gaining an understanding of the basics of inflation, you’ll find strategies for helping you hedge your portfolio against the pitfalls of inflation trends. With the right information, long-term investors can think more strategically about how to achieve their financial goals.
Understanding What Inflation Is
You may have heard the term “inflation” in the news in connection with stories about the economy, and you might have guessed that when prices are inflating, they’re growing, just as a balloon grows when it inflates.
To be more specific, inflation is the rate at which prices of goods and services in an economy, such as the U.S. economy, rise in a specific time period. For investors, inflation comes with many different advantages and disadvantages.
Is Inflation Good or Bad?
Inflation is neither good nor bad. Instead, whether inflation is beneficial depends on your personal financial situation.
Primarily, we think of higher inflation leading to the unfortunate situation in which your money buys you less – it has less purchasing power. So, if you’re in the market for buying, higher inflation would be considered a negative for you because wouldn’t be able to buy as much due to inflationary higher prices.
In other words, if you hold a lot of cash during inflation, then inflation would be working against you because the value of your money would decline.
On the flip side, if you are holding a lot of goods that are increasing in price, then you can see where inflation would be a positive.
That’s because you could sell those goods for more money, so the value of your holdings would increase.
What Causes Inflation?
A number of factors can cause inflation. Basic economic principles can explain many price increases. First, inflation can occur when demand for a product or service rises, assuming the supply stays the same.
Second, if the demand remains the same, but the supply shrinks, then prices rise. Prices can also rise for the consumer when the cost to make the product or provide the service increases.
As an example of how supply and demand can affect prices, consider how much you pay for gas.
You’ve probably noticed that price changes regularly. That’s mainly based on how much supply is available at that particular time, which is determined by how much producers release, as well as how often drivers are driving and using gas.
For instance, if people are not driving as much and the supply is higher, you’ll see much lower gas prices at the pump, whereas when producers hold back on releasing their oil and gas products, you’re likely to see higher gas prices.
Another factor that can drive inflation is when a central bank intervenes to adjust interest rates. Government regulation can lower interest rates, which might cause more inflation, or increase interest rates, which can basically pump the brakes on inflation.
Finally, the government can also play a role in causing inflation simply by printing more money. With more money in the system, the value of the current money declines, which leads to lower purchasing power – that’s exactly what inflation is.
How Inflation is Measured
One common way inflation is measured in the U.S. is through the Bureau of Labor Statistic’s (BLS) Consumer Price Index (CPI). It tracks changes in the price of different categories of goods and services, like food, clothing, cars, commodities, and gas, among many others.
Another measure of inflation is the Wholesale Price Index (WPI). This kind of index measures how prices from wholesalers or manufacturers change, instead of how prices for the consumer change as the CPI measures.
What You Need to Know About Investing During Inflation
Inflation trends have a number of consequences for real estate investors, depending on what kind of assets they have and what kind of decisions they plan to make for buying and selling assets.
First, let’s consider real estate. Most intelligent investors and savvy advisors will recommend holding real estate, in part for how such investments can benefit an investor during an inflationary period as an asset that consistently retains and increases its value. Housing prices over the last 100+ years have tracked, if not exceeded inflation. As the value of your property rises due to this inflationary effect, together with general rising prices over time, the overall value of your real property asset increases two-fold.
In this inflationary scenario, the cost of goods goes up, wages follow, and so does rent. If you’re a property owner, you can increase your rents to meet inflation. Furthermore, consider that if you took out a fixed loan on the property, your payments will remain the same for the duration of the loan, but your property value will likely appreciate with inflation. Stop and think about that for a second. You’re paying the same amount, which dollar value is actually less, for a more valuable piece of property.
In contrast, some stocks can be very volatile during inflation as the market adjusts according to consumer behavior. How a stock performs generally depends on how each particular company is impacted by high inflation. Hence, the stock market roller coaster.
The Bottom Line
Intelligent, informed investors often invest in real estate investors as a way to diversify their portfolio and hedge against inflation so that they can better ride the ups and downs of inflation trends. However, keep in mind that no investment strategy is a guarantee.
Author Seth Bradley from passiveincomeattorney.com.
Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.