We all have been told real estate is a great hedge against inflation, especially multi-family real estate. But have you ever wondered why that is? Or perhaps you have read the articles, but have not met anyone in your personal life who invests in multi-family syndications. This may leave you feeling like you don’t have all the information you need to be convinced. Guess what, you’re not alone. It seems the more people we meet and talk to about passive investing, the more we are told investors are interested in getting into these investments, but they don’t know exactly how or who to invest with. For that reason, we’d like to review just exactly why multi-family syndications are a beneficial piece of your investment portfolio.
What Is Inflation?
Inflation is the decline in purchasing power of a given currency over time. On a more relatable level, it’s the measure of the rise in the cost of living. This has become a significant concern in recent months. The decreasing value of currency requires more dollars to purchase a given good or service.
Let’s take a look at a couple of examples:
A basket of groceries that previously cost you $100 may now cost you upwards of $120 or $130 and that’s just at the grocery store. The effects of inflation are felt in almost all consumer goods, as well as the price of property, gold, stocks, and more. When we are faced with these increases on goods and services in our everyday lives, we have to decide if we are going to earn more money, or purchase and sustain our family on less.
One year ago, Rebecca purchased a multi-family community for $1,000,000. Over the past year, she saw a normal inflation rate of 3%. Now, Rebecca’s asset is worth $1,030,928 [($1,000,000/$970,000) *$1,000,000]. Had she been holding $1,000,000 in her savings account for the same period, it would have lost value due to decreased purchasing power. Instead, because she invested in multi-family real estate, she was able to see increased value due to inflation. Now, imagine the following year Rebecca experienced 10% inflation. The asset she purchased for $1,000,000 two years ago is worth $1,145,475 simply because of the compounding inflation year over year.
You can see from these examples, that it’s important to dig and understand concepts from multiple perspectives. I’m sure you’ve been inundated with articles and news about inflation and how it negatively impacts your finances and your family. But as these two examples have shown, it can come down to where you invest your money and the financial moves you make.
How do real estate investments protect investors against inflation?
Unfortunately, in the U.S., we’re experiencing record-high inflation, the highest we’ve seen in 40. The one thing that remains certain in these uncertain times is that commercial real estate as an inflation hedge.
Nationwide rental rates have continued their steep year-over-year climb due to a multitude of reasons. The housing crisis of the early 2000s and the subsequent years of under-building left those who rushed to buy a home during the early stages of the Pandemic with very few options. Some paid a premium home price while others settled back into renting.
As the Pandemic has worn on, a lack of available properties has been exacerbated by work stoppages, raw materials shortages, and labor constraints, all of which have kept builders from increasing output to meet demand.
This can feel overwhelming and defeating for most consumers, but we think it’s a great opportunity for your investment portfolio. The higher the rent, the more money you will make! When you own commercial real estate (with almost no specificity to a particular asset class), you earn more money simply because of inflation. So, while others’ income is strained due to inflation and skyrocketing rents, your income and overall net worth increase, nearly at the same rate as inflation. Now, let’s investigate why real estate investors have an excellent hedge against inflation, even when everyone else feels a decline in purchasing power.
#1 – Real Estate Prices:
As we pointed out at the start of this post, physical assets appreciate more quickly during inflation. Eventually, prices will likely even out, but experts are predicting 6%-9% increases will remain across the country. Commercial real estate is valued based on the rental income collected, rising rents will continue to drive up the value of the asset. For this reason, many investors see these assets as a strong investment as they have “built-in” inflation protection.
#2 – Next up, Mortgage Interest Rates:
Fixed-rate loans do not change interest rates for the duration of the debt agreement even when the investor’s equity in the property grows. During inflationary times, as real estate prices soar, assets appreciate at a more rapid pace yet their payments remain unchanged. This works in the investor’s favor. It builds equity in the portfolio and allows the investor to reinvest the equity into additional investment properties. This allows them to further capitalize on the inflation protection power of real estate investments.
#3 – Scarcity:
The price of multi-family real estate property is partially driven by supply and demand. This can also be viewed as perceived scarcity. This is especially true in metropolitan areas where population growth has created a limited supply of space. When demand is high, but space isn’t readily available, real estate investors benefit. Right now in the U.S., the population continues to increase while construction and renovation of real estate assets have decreased. This has resulted in an all-time high in property scarcity, and those who own income-producing real estate are benefiting greatly.
How to keep your current gains and continue to build wealth as inflation takes hold:
Picking what to invest your hard-earned money into can be stressful and confusing. Recently, a family member told me they have money ready but were waiting for a “safe” investment. Unfortunately, no investment is absolutely guaranteed to be safe. But, it is guaranteed that those holding on to cash during a period of high inflation are only going to lose in the long run. The sustainability of multi-family investing is one of the key drivers motivating new investors to jump in. Investors who understand the advantage of relying on real estate are currently building their wealth at an accelerated speed.
Click here to watch a Meetup recording on discussing this topic with other like-minded investors.