Everyday investors are regularly inundated by financial news outlets warning about the risks of inflation. But it seems like the noise creates more confusion and unanswered questions. That’s particularly the case because nobody can in fact properly gauge the rate of inflation.
What’s too much inflation? What’s too little inflation? How do I protect myself from inflation and still earn a decent return on investment? What is inflation?
In this article we’ll arm you with the basics on inflation and how online real estate investing can help you prepare for inflation like the pros.
What is inflation and what causes it?
First of all, let’s be clear. Everyone uses the term inflation to fit whatever particular narrative they are selling, or of which they are fearful, or which they don’t understand. For the purpose here, let’s broadly define inflation as when the prices of goods and services rise. It takes more of a particular currency to acquire something desirable or necessary.
But of course, there are many factors beyond inflation that affect how much something costs. Primarily, that’s supply and demand.
So perhaps we can say that inflation is in the background then, something increasing the costs to acquire assets simultaneously and reducing the cost of extinguishing liabilities and obligations. This matters because a billion percentage inflation was not going to save the malls, because the dead malls had a supply and demand problem and no amount of inflation was going to create a scenario in which Radio Shack and the Sharper Image were staying out of bankruptcy.
How do I protect my portfolio against inflation?
There’s no magic formula to hedge against inflation.
Among the worst performers in the face of inflation are bonds – they provide regular coupon payments and the promise of principal repayment. But as inflation increases and relative purchasing power of a dollar is reduced, so is the value of that bond’s cash stream. That’s why bonds offer the least protection of any major asset class against inflation.
But flip that around, and there is one of the best reasons that real estate does in fact as a hedge, because you can apply long term debt financing to the asset. Supply and demand aside, borrowing long term, fixed rate debt in an inflationary regime is indisputably a win for owners who choose such financing. (Short term, floating rate financing, not so much).
Commercial real estate: The best of both worlds
Real estate sits on land. In particularly densely-populated or growing areas, the structures that sit on these land parcels produce income based on demand for homes, offices, retail centers, hotels or warehouses – whatever the use may be.
The first step for you as an investor is determining a product and location that you believe commands persistent pricing power. Because at the end of the day, you can fix your obligations, but without pricing power (see, earlier, dead malls) there is no chance you will outperform inflation. That’s why quality and use matters. It’s why the pandemic has created uncertainty of what types of improvements and locations will exhibit strong pricing power going forward, and why statements like “real estate is an inflation hedge” might be true but might also be incredibly misleading.
But in good locations, in asset types with limited supply and healthy fundamental demand growth, historically it has been an accurate statement to say that real estate generally has not only maintained, but greatly increased, in intrinsic value.
It’s those properties in which real estate owners can adjust their rental rates upward to keep up with increases in the general price level, creating the potential for dividend growth to match inflation. That’s why many institutional investors, those looking to “have their cake and eat it too,” turn to real estate to hedge against inflation. But don’t get it confused, it’s not as simple as “buy real estate.”
But it gets better…
Not only does real estate generally hold its intrinsic value, but rental rate structures generally allow dividends to grow during inflationary periods. Real estate owners can regularly adjust their rental rates, creating the potential for dividend growth to match inflation. That’s why billionaire investing elites, looking to “have their cake and eat it too,” turn to real estate to hedge against inflation. It’s no coincidence that 35 of the wealthiest 400 Americans amassed their fortunes in real estate, according to Forbes.
Online real estate platforms – The inflation hedge for the everyday investor
Until recently, financial planners could only offer commercial real estate investments to their wealthiest clients, those that are accredited investors. Now with the emergence of online real estate platforms like Streitwise that offer low investment minimums, everyday investors can use commercial real estate to hedge against inflation like high net-worth institutional investors.
