Amanda Han, Author & CPA at the Award Winning Keystone CPA, Inc. - Specializing in tax strategies for real estate investors nationwide.
In unprecedented times, uncertainty can be your greatest enemy or your greatest asset.
It’s been a long time since “business as usual.” Between Covid-19, burgeoning inflation and heightened volatility, the last few years have been a roller coaster for consumers and investors alike. While this uncertainty has caused many Americans to put their investment plans on hold, others are seeing this as an opportunity of a lifetime.
Amid rising real estate prices, many investors are questioning if now is the right time to buy. Savvy investors, however, know that market value isn’t the only factor at play, and the opportunity to hedge against inflation and taxes makes now a prime time to consider real estate investing.
Beating Inflation
After several years of hovering around 1%-2%, year-over-year inflation jumped to a high of 9% in mid-2022. While most people have felt this punch the hardest in their gas tanks and grocery lists, others have found ways to make inflation work in their favor.
While inflation can hurt investors who are seeing the buying power of their dollars dry up, it’s also an opportunity to see a higher return on their assets. Property values tend to generally trend upward in normal markets, but an inflationary market makes real estate an especially attractive option.
Inflation means the cost of living is on the rise while purchasing power is on the decline. What does this mean for you? As a real estate investor, your property value will likely continue to rise while your mortgage payment stays the same. Although the ability to lock in a loan with a lower interest rate is key to wealth-building during inflationary times, even adjustable-rate mortgages may be shielded from extremes in volatility by adjustment caps.
2. Inflation Can lead To Higher Rental Income
As housing prices rise, more consumers are looking toward renting rather than buying. Real estate investors can capitalize on this increased demand by charging higher rent while retaining lower mortgage payments. Not only does inflation create higher rental incomes, but it also creates new renters—a combination that real estate investors can benefit from.
3. Real Estate Appreciates Over Time
In 2022, the average interest rate in a checking account is 0.03%. In a year that’s seen over 8% interest, it doesn’t take a mathematician to realize that your money can’t win the game from the bench. While inflation punishes those who wait, it rewards those who invest in appreciating assets like real estate. Not only does real estate create a recurring revenue stream, but it tends to hold its own against inflation through appreciation.
Saving Taxes
No matter how profitable your investments are, what matters most is how much of it you actually get to keep. As a real estate investor, you are a business owner in the eyes of the IRS. This means that you can take advantage of all the tax-saving deductions available to you.
In general, inflation augments tax expenses. As the cost-of-living rises, so do wages. Tax brackets, however, stay relatively the same.
As your earnings increase, you may be pushed into a higher tax bracket—resulting in more money lost to taxes. This is a phenomenon that’s only compounded by inflation. It’s not all bad news, though; fortunately, the tax code includes many benefits that real estate investors can take advantage of:
1. Write Off Business Expenses
Did you pay for property insurance? Purchase a real estate membership? Attend a real estate conference? If so, these costs may be tax deductible as business expenses. Since the tax code views real estate investors as business owners (whether you’ve incorporated or formed a business entity or not), any ordinary and necessary expenses related to your real estate investments are generally tax deductible.
2. Take Advantage Of Appreciation
As we previously touched on, inflation generally leads to higher taxes because income tends to increase as tax brackets stay the same. While this is a disadvantage in terms of rental income, it can work in your favor in terms of property value.
As property values continue to rise and inflation drives prices higher, the appreciated value of your property is not subject to capital gains taxes until you realize those gains. This means that the property you buy today for $300,000 may be worth $500,000 in a few years, but you don’t pay capital gains taxes on that $200,000 increase of equity until you sell the property.
This is important for you because it means your asset is growing without the tax drag. It also means that you can borrow against that additional equity via cash-out refinances—all without paying taxes on that appreciation until the time is right to sell.
3. Sell Real Estate Efficiently
One of the most popular tax benefits for real estate investors is the ability to defer capital gains tax using a 1031 exchange. This tax benefit allows you to sell one investment property and defer the capital gains tax by immediately purchasing another investment property.
Like the rest of the tax code, there are several special rules about 1031 exchanges, so be sure to seek professional advice when using this strategy. If done correctly, this strategy can help defer a significant amount of taxes.
A 1031 exchange gives you greater control over when you pay capital gains tax. In inflationary times, that means you can defer your tax obligation into the future when you will pay with inflated dollars.
Make Unprecedented Times Work In Your Favor
Inflation and taxes are two of the biggest silent wealth killers. However, with some savvy investing strategies, even the most tumultuous markets can work in your favor.
There is little that you can do to control inflation and taxation, but real estate investing can open doors to unique opportunities in even the most unprecedented times.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
Real estate has long been considered one of the best hedges against inflation because you can pay less for your home over time compared to what you may pay in rising rent. This can help your wallet as you pay more for everyday items.
Real estate has long been considered one of the best hedges against inflation because you can pay less for your home over time compared to what you may pay in rising rent. This can help your wallet as you pay more for everyday items.
Move Your Money into a High-Yield Savings Account. If you have your money stashed in a checking or basic savings account—or worse, at home—inflation erodes the value over time. ...
Real estate usually performs well in inflationary climates; REITs are the most feasible way to invest. Adding global stocks or bonds to your portfolio also hedges your portfolio against domestic inflationary cycles. Another option is more exotic debt instruments like TIPS (inflation-adjusted Treasury bonds).
However, remember that although real estate can be an effective inflation hedge, it is still subject to the same economic forces that drive inflation in the first place. Inflation erodes the value of money, which can reduce investors' returns due to rising costs associated with mortgages or renovations.
If you're a property owner, the high inflation rate could be good news for you. As prices increase, the value of your property goes up as well. You may be able to sell your property for a higher price than you paid for it, or use it as collateral for a loan.
For example, if the dollar loses value from the effects of inflation, gold tends to become more expensive. So an owner of gold is protected (or hedged) against a falling dollar because, as inflation rises and erodes the value of the dollar, the cost of every ounce of gold in dollars will rise as a result.
The ideal investments for hedging against inflation include those that maintain their value during inflation or that increase in value over a specified period of time. Traditionally, investments such as gold and real estate are preferred as a good hedge against inflation.
Rental income: Real estate investments can provide a steady stream of rental income, which can also help beat inflation. Rents tend to increase over time, particularly in areas with strong job growth and population growth. This means that rental income can also increase over time, providing a hedge against inflation.
As this price of things increases with inflation, so too does real estate. Generally speaking, when inflation increases then housing and other real estate asset prices follow suit.
Real estate works well with inflation. This is because, as inflation rises, so do property values, and so does the amount a landlord can charge for rent. This results in the landlord earning a higher rental income over time. This helps to keep pace with the rise in inflation.
Not only does real estate create a recurring revenue stream, but it tends to hold its own against inflation through appreciation. No matter how profitable your investments are, what matters most is how much of it you actually get to keep. As a real estate investor, you are a business owner in the eyes of the IRS.
An allocation to real assets may therefore help to preserve future purchasing power, potentially offsetting the vulnerability to unexpected inflation that is historically common to traditional portfolios of stocks and bonds.
In conclusion, a high-interest rate environment can be a great time to buy an investment property if you know what you are doing. The market may spook other investors and landlords, and you can come in and find hidden gems.
Bonds or debt funds that invest in bonds are linked closely to interest rates in the economy, which works closely with the inflation rates. If inflation rises, interest rates rise. Interest rates and bond prices move in opposite directions. Hence bond prices will fall in this case.
Since higher interest rates generally accompany higher inflation, an inflationary environment can have a negative effect on fixed-income securities, such as bonds and mutual funds invested in bonds. This is because bond prices tend to move in the opposite direction of interest rates.
That said, inflation commonly occurs due to the actions taken by the Federal Reserve. Overall, when more money becomes available, the purchasing power of a dollar decreases, which in turn increases the price of goods and services. Unfortunately, inflation affects most products and services, including real estate.
In inflationary times, fewer new builds and other development plans can get off the ground due to rising costs of construction-related products and services. This leads to plummeting property inventory levels, keeping demand ratios high and thus increasing prices.
There are several effective hedging strategies to reduce market risk, depending on the asset or portfolio of assets being hedged. Three popular ones are portfolio construction, options, and volatility indicators.
Does real estate perform well during stagflation? Yes, real estate is one of the top performers during stagflation. This often has to do with a slowdown in new construction. In addition, the trend of fewer people buying new homes means more renters.
Real estate is a great asset to own when the economy is in freefall. A rental property typically acts as a natural hedge in a volatile market. Primarily because many people that sell their homes or properties during an economic downturn or recession need to sell their property.
Why is Real Estate considered inflation-proof? Real Estate is often cited as the ideal solution for protecting one's money against inflation. And for a good reason: residential property is a tangible asset that, like all other products, increases in value in times of inflation.
In short, the increase in home prices outpaced inflation by 3.7% overall in 2022. However, between July 2022 and January 2023, inflation outpaced housing prices by 2.5%. As the Federal Reserve interest rate changes, which has meant increases in the past year, so does inflation — and home prices along with it.
Real estate has historically provided a strong inflation hedge. Key to this is the ability for landlords to re-price rents upward. Higher construction and materials costs theoretically increase the replacement cost of existing assets while also restricting new supply, which tends to keep rents high.
Investing in farmland as an inflation hedge. There's one more big reason that farmland is an especially compelling investment right now: inflation. Unlike mainstream financial assets, which tend to lose value when consumer prices go up, the value of farmland actually tends to rise when prices rise.
Real estate broadly has been a useful hedge against inflation. In every period, at least one CRE sector—multifamily, office, retail, or industrial—beat inflation. And in six of the seven inflationary periods, the period's top-performing sector outperformed both stocks and bonds.
There are several strategies for keeping the value of your assets from depreciating during stagflation, including buying real estate, commodities trading, buying value stocks, and investment in gold and other precious metals.
Hedging is a risk management strategy employed to offset losses in investments by taking an opposite position in a related asset. The reduction in risk provided by hedging also typically results in a reduction in potential profits. Hedging requires one to pay money for the protection it provides, known as the premium.
Looking at the data, inflation-adjusted returns, even factoring in inflation, have almost always been positive in history - meaning that price appreciation for real estate is greater than the inflation rate!
As of mid-2022, California's real estate market is one of the strongest and most dynamic in the country. That alone should answer the question of is California real estate a good investment, but it's important to note that it's also a sweeping generalization.
If you think you could lose your job in a recession, real estate may be too significant an investment to be worth it right now. If you have a stable job with long-term prospects, sizable cash reserves and don't mind some risk, a downturn could be the ideal time to invest in real estate.
Therefore, they are linked to a decrease in monetary value. Following this reasoning, real estate should decrease its nominal value under deflation (negative inflation rates), and bonds should protect against an increase in monetary value, since a negative interest rate is uneconomical.
Address: Suite 751 871 Lissette Throughway, West Kittie, NH 41603
Phone: +2366831109631
Job: Sales Producer
Hobby: Creative writing, Motor sports, Do it yourself, Skateboarding, Coffee roasting, Calligraphy, Stand-up comedy
Introduction: My name is Laurine Ryan, I am a adorable, fair, graceful, spotless, gorgeous, homely, cooperative person who loves writing and wants to share my knowledge and understanding with you.
We notice you're using an ad blocker
Without advertising income, we can't keep making this site awesome for you.
