Are Real Estate Investments Resistant to Inflation?

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Are Real Estate Investments Resistant to InflationOne of the common phrases heard in real estate circles is that investing in real estate is inflation-proof.

I thought I’d take a look at why that might be.

First of all, what exactly is inflation?

Inflation is simply the rate at which the price of goods and services rises over a period of time. This can be detrimental for you, as the value, or purchasing power, of your money diminishes.

In other words, if you could once buy bread for $2, it might now cost $2.50. If milk was $3, it might now cost $3.50.

Your dollar’s purchasing power diminishes over time. Does anyone remember when you could buy a soda for 50 cents?

In essence, although the number on the bill in your wallet hasn’t changed, it’s losing value just sitting there.

Physician Financial ServicesWhy does inflation happen?

I have to start out by admitting that I am not an economist. I took a few courses on macro and microeconomics in college, but I am in no way an expert on the subject.

One big thing I do remember from back then is the concept of supply and demand. This is one of the most fundamental concepts of economics, and the main governing force behind pricing.

Supply and demand are linked and when one outpaces the other, there is a change in the economics or the pricing of a product or service tends to shift. This can ultimately lead to inflation.

To dig into it a bit, the most common reason for inflation is what economists refer to as ‘demand-pull inflation’. It occurs when demand outpaces supply. This leads to a willingness on buyers’ parts to pay higher prices for a highly desired product or service.

For example, imagine the scenario where the demand for a certain car is through the roof (maybe due to awesome new technology at a good price), but there’s not enough made for everyone to have one. People who really wanted the car might then be willing to pay even more to get their hands on it. You had better believe the car manufacturer will figure out a way to increase the price of it to meet that demand!

There’s also something called ‘cost-push inflation’ that occurs when demand remains the same, but the supply diminishes. An example of this is whenever there has been a shortage of oil, gas prices in this country skyrocket.

People also debate whether an increase in the printing of money causes inflation. The thought is that as you release more paper bills into circulation, the value of each of them decreases.

There have definitely been times in history when certain countries have tried printing money to revive their economy, and the result has been something called ‘hyperinflation,’ where the value of the currency plummets.

How is inflation measured?

Inflation isn’t completely static. Every year it’s different, but over the last 100 years, it’s averaged a bit over 3% per year. In the last decade though, it’s averaged a bit over 2%.

So how is it most commonly measured?

Well, the US Bureau of Labor Statistics uses a metric called Consumer Price Index (CPI) to track it. It is the measure of the average change in the prices paid by consumers over time for a basket of goods and services.

These things include tracking prices of food, transportation, or health care, to name a few.

Are Real Estate Investments Resistant to Inflation?

Is inflation is always a bad thing?

Well, Ronald Reagan once spoke these words, “Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man.” Makes it seem like inflation is a pretty nasty character.

However, economists say that some inflation is not necessarily a bad thing because it forces people to not just horde their cash. If the value of it is diminishing, people will put that cash to use. It encourages some spending and investments and that helps to grow the economy.

Personal Capital (All Accounts)Who controls inflation?

Well in this country, it’s the Federal Reserve that controls inflation.

“The central focus of what we are doing at the Fed is to keep inflation from accelerating – and preferably decelerating.” – Alan Greenspan

Without getting into the weeds, they use monetary policy to control inflation, prevent deflation, and try to help promote a stable economy.

Why is real estate inflation resistant?

Different economists, like Shiller, have tracked housing prices as an investment over time:

Are Real Estate Investments Resistant to Inflation?

Through his studies and countless others, they’ve shown that housing prices over the last 120 years have followed the rise of inflation if not exceeded it.

That’s because, along with many other products (like bread and milk) mentioned before, housing isn’t a luxury, it’s a necessity. So people will spend money for housing. And just like the prices for those products will rise over time, so will the cost of housing.

We all know that appreciation of the value of a real estate investment is only one way real estate investors make money. They also make money through monthly cash flow. This is calculated by taking the income (rent) minus expenses.

Well, as inflation and the cost of goods goes up, so do wages to match. As wages increase, so does the cost of rent. So as a property owner, you’re able to increase rents to fall in line with inflation. That’s part of the reason if you’ve been a renter, the cost of rent seems to increase at least 3% each year.

If you took out a loan to purchase your home or a rental property, there’s a decent chance you used a loan at a fixed rate. If so, the appreciation of your house value may be increasing in line with inflation, however, your fixed rate payments will stay the same. You might be making a monthly payment of $5000 for 30 years, but in those later years, that $5000 that you’re still paying is actually worth less as a result of inflation.

So as you can see, there are multiple reasons why real estate can provide a reliable hedge against inflation, and another added benefit of investing in real estate.

Any other reasons that real estate is inflation resistant? What other things are inflation resistant?


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3 COMMENTS

  1. I think that’s why real estate investments, particularly multifamily apartments, are considered “evergreen” investments. Humans will always need shelter, there is no threat of a disruptive force like Amazon coming in an obviating that need.

    As costs go up, rents will rise to correspond with this and overall net effect will be stable, or as you pointed out positive compared to inflation.

    Another reason why things get more expensive with time is that labor gets more expensive as workers get raises, etc. So the same product will cost more to make even if all the other variables stay the same.

    I am no economist, but it does seem interesting that people typically get a 3% raise which matches the cost of living increases most of the time, so doesn’t the net effect really remain the same?

  2. Regarding the Federal Reserve — I’ve heard that one reason why they try to ensure that there is slow and steady inflation is to erode the value of our national debt. Essentially, with inflation the US will owe less over time (unless we continue to have a deficit…).

    A nice side effect is that the long term debt of real estate mortgages also is getting eroded with time.

    Good for real estate investors, not so good for simple savers.

    — TDD

  3. The argument presumes demand. Cash flow in the 20 year old is being diverted into loans that can not be excused. The destination is colleges, not housing, so effectively your tidy little real estate empire is in direct competition with college cost and health care cost, even putting gas in the car cost. This results in the apartment not being rented or a reduction in rent across units and this is called deflation. How many Millennials are living at home or crashing on a couch? How many are escaping all together and moving to India or something? If you live in India you won’t be renting in Houston. Real Estate has some pricing elasticity but its hardly guaranteed or safe. Whole lotta properties were abandoned in 2008. We just happen to live in a time where people are flush, employed, and not deflating. The FED went through extraordinary measures to keep us from deflating by moving toxic debt to their balance sheet and letting the banks idle on a 2% profit margin while the public repaired their balance sheets and repair they did. Had the fed not acted deflation would have ensued, people would be hanging onto their money and rents would be cut in half. Wonder how long you can service that loan with a cut in half rent? Do not ask for who the bell tolls and every day face east and bow once to Hank Paulson for saving your bacon.

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