Real estate is often presented as the “ultimate” hedge against inflation. Understanding why and how real estate remains one of the safest investments during inflationary times is as simple as 1,2,3.
1). Back to the basics
Inflation is the continuous increase in the price of goods and services over a given period of time: usually a year. As a result, the consumers ‘purchasing power erodes as it takes more money to buy the same items because prices are rising.
The 3 main causes of inflation are a) Demand-pull which occurs when the demand for certain goods and services is greater than the economy's ability to meet those demands; b) Wage-Price spiral which occurs when workers demand higher wages to keep up with rising living costs; c) Wage-push inflation which happens as a result of increases in the cost of wages and raw materials.
2). Safety: The number one advantage of real estate ownership during inflationary periods
According to the Federal Reserve, the median sales price of houses sold in the U.S. increased by nearly 20% since Q3 2020. By comparison, the 10-Year Treasury yield is around 1.5%, and high-yield savings accounts only offer an annual percentage yield of 0.60% or less. As a reminder, a 10-year Treasury note is a debt obligation issued by the United States government with a maturity of 10 years upon initial issuance. A 10-year Treasury note pays interest at a fixed rate once every six months and pays the face value to the holder at maturity.
In the same vein, property values tend to perform better than stocks during inflationary times as they are less volatile meaning there are fewer chances that they will change quickly and unpredictably like the stock market.
As explained above, during inflationary periods real estate is a safer investment than bonds and stocks even when home prices are going down. The majority of the homes that hit rock bottom when the real estate bubble burst in 2008 came back to their pre-crash prices in less than a decade.
3) Ownership can help you mitigate your loss during inflationary times
The effect of inflation on mortgage payments is equal to zero as fixed-rate mortgage payments remain the same when most of your other expenses are going up.
Owning rental properties may offer the homeowners the opportunity to pass through some of the rising costs due to inflation, to the tenants in the form of higher monthly rent. As a result, if you can adjust your rent while keeping your mortgage the same, you are less at risk to lose money because the prices of goods and services are rising.
To conclude, real estate is a real shield against inflation as long as you do not sell your property at a time and/or at a price that would wipe out most or all the equity you built over the years. Also for the record, as pointed out in my previous blog, the current real estate market is not crashing it is only decelerating. In other words, the real estate market is simply entering into a stabilization/ normalization phase which has nothing to do with a real estate market crash where there are too many homes for sale and not enough buyers which consequently leads to lower selling prices and equity loss. For the record, as of today, the supply of homes for sale remains near record lows.
Hope this helps.
Sources:
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