The effect of inflation on real estate investors – Stessa (2024)

FAQs

How does inflation affect real estate investors? ›

Real estate as a hedge against inflation

Investors commonly purchase tangible assets such as real estate to hedge against inflation. Other investments, such as stocks, typically react negatively to rising inflation, but property responds proportionally, often increasing in value as inflation creeps up.

When inflation is high, the costs of materials also increase. That means it may become especially expensive for construction teams to build new homes or renovate existing homes. Ultimately, those high costs could spill into the housing market and lift home prices for new builds.

As inflation increases, so does the price of everything, including mortgage rates." Inflation also reduces the demand that investors have for mortgage-backed bonds. As demand drops, the prices of mortgage-backed securities fall. That results in higher interest rates for all mortgage types.

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.

The impact of inflation on investments depends on the investment type. For investments with a set annual return, like regular bonds or bank certificates of deposit, inflation can hurt performance — since you earn the same interest payment each year, it can cut into your earnings.

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.

High inflation has a greater effect on real estate cycles than business cycles because real estate costs are more significant. For Example: A 10% increase on a $100,000 home (a $10,000 increase) would make a buyer think harder about his purchase than a 10% increase on a $50 pair of shoes (a $5 increase).

In an inflationary environment, unevenly rising prices inevitably reduce the purchasing power of some consumers, and this erosion of real income is the single biggest cost of inflation. Inflation can also distort purchasing power over time for recipients and payers of fixed interest rates.

Will house prices go down in a recession? While the cost of financing a home typically increases when interest rates are on the rise, home prices themselves may actually decline. “Usually, during a recession or periods of higher interest rates, demand slows and values of homes come down,” says Miller.

Inflation allows borrowers to pay lenders back with money worth less than when it was originally borrowed, which benefits borrowers. When inflation causes higher prices, the demand for credit increases, raising interest rates, which benefits lenders.

Why is real estate a good investment during high inflation? ›

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.

Holding long-term fixed-rate investments, such as long-term bonds, fixed annuities, and some types of life insurance policies, during inflation can be bad because their returns may not keep up with inflation.

After peaking at 6.2% in 2022, we expect inflation to fall to 3.5% for 2023. Over 2024 to 2027, we expect inflation to average just 1.8%—below the Fed's 2% target.

High-yield debt—as it's officially known—tends to gain in value when inflation rises, as investors turn to the higher returns offered by this riskier-than-average fixed-income investment.

While stocks are generally good investments for fighting inflation over time, high inflation can negatively affect stocks. For this reason, stock prices tend to be volatile during periods of high inflation.

Protecting against high inflation is difficult for investors. Higher inflation – and higher interest rates to curb them – has an adverse effect on most asset prices. The problematic scenario for investors is that a simplistic 'traditional' portfolio of equities and conventional bonds is not inflation-resilient.

Inflation can lead to higher asset prices

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 typically outperforms other assets in terms of value appreciation. Furthermore, it is not as susceptible to short-term volatility as the stock market. Whether you rent out an apartment or a business property for income or buy a home, you obtain a physical, usable asset.

Frequently Asked Questions About Stagflation

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.

Does inflation hurt the stock market? An inflation rate between 1% to 3% is typically considered healthy for stocks. Periods of high inflation, on the other hand, often cause uncertainty, volatility and a slowdown in spending, leading to lower economic growth.

Why do you think high inflation might hit a real estate cycle harder than a business cycle? ›

High inflation hits a real estate cycle harder than a business cycle primarily because the actual costs are larger.

Key Takeaways. The housing market is a good example of how supply and demand works within an industry. When the demand for housing is high, but supply is low, home prices often rise. When there is a glut of housing available in a market, homeowners may lower their prices due to less demand in the market.

Inflation is measured by the consumer price index (CPI), and at low rates, it keeps the economy healthy. But when the rate of inflation rises rapidly, it can result in lower purchasing power, higher interest rates, slower economic growth and other negative economic effects.

Drawing upon recent household survey data, we show that high inflation is disproportionately hurting low-income households, including Black and Hispanic households and renters.

Will house prices go down in a recession? While the cost of financing a home typically increases when interest rates are on the rise, home prices themselves may actually decline. “Usually, during a recession or periods of higher interest rates, demand slows and values of homes come down,” says Miller.

Because people have less money to spend, demand falls, taking the prices of many goods and services with it. Because a decline in disposable income affects prices, the prices of essentials, such as food and utilities, often stay the same.

Just because there's a recession doesn't necessarily mean rent prices go down. In fact, during the 2008 recession, it was the exact opposite. In the current rental market, we have seen the rate of increase in rental prices come down, but this only translates to lower rent prices if you're in select markets.

Volatile stock market

High rates of inflation and rising prices could lead to more stock market volatility, which would be more damaging to retirees who are constantly withdrawing from their investment accounts.

Is real estate a good investment in 2023? ›

In my opinion, real estate is one intelligent option to consider in 2023, as it often has excellent returns, tax advantages and provides diversification even in the face of a challenging economic climate. Real estate also has the potential to compound your investment.

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.

Why is Inflation Bad for Stocks? Rising prices of goods and services injects uncertainty into the markets. During periods of rising inflation, corporations profit and growth margins may be hit, affecting investor confidence which in turn affects their willingness to take on risk by holding stocks.

If the inflation rate is higher than expected, the investor's real rate of return will be lower than expected. An unexpected change in the inflation rate also affects the real rate of return. An investor lending money will demand an interest rate based on her expectations for inflation.

In general, inflation benefits borrowers who have lower fixed interest rates and owners of assets that rise along with inflation. The relative costs of servicing these debts becomes less expensive with inflation.

Inflation is bad for investors because it reduces the purchasing power of their money. When prices go up, the same amount of money buys less than it did before. This is especially harmful to retirees and other fixed-income investors who depend on their savings to cover their living expenses.

The best option for keeping up your personal finances when inflation rises is to keep a percentage of your money in long-term investments as part of a diversified portfolio. Retirement accounts, for example, are commonly used as a way to grow your money slowly over time and keep up with the natural rise of inflation.

The impact inflation has on the time value of money is that it decreases the value of a dollar over time.

Long-Term Security

Real estate is a long-term investment, meaning you can hold it for several years as you wait for it to appreciate. At the same time, if you rent out your real estate you can earn monthly income while you wait for your property's value to rise.

Inflation allows borrowers to pay lenders back with money worth less than when it was originally borrowed, which benefits borrowers. When inflation causes higher prices, the demand for credit increases, raising interest rates, which benefits lenders.

What investments do well during inflation? ›