Using Real Estate as an Inflation Hedge
It's an invisible tax that's eroding your buying power by 6-10% annually - grocery bills are higher, energy prices have skyrocketed, and wages aren't keeping up.
And the stock market has only gotten more volatile, especially amidst fears of rising interest rates and an economic slowdown.
So how do you combat these challenges? Real estate offers a solution - check out this video to learn more about using real estate as an inflation hedge.
Guide to the video
- Rental rate increases through short-term leases and rental escalators are effective at keeping pace with inflation
- When the price of inputs increases, the value of new and existing real estate generally also increases
- Inflation can't be avoided, but a strategy for asset diversification can help prevent buying power erosion.
- Real estate investing has proven to be more effective over the long-term than gold or precious metals at hedging inflation
Video transcript follows
I think it’s pretty clear that inflation is not in fact “transitory” as we had been promised.
Every month as new inflation numbers come out, we set a new 40-year record high. And it would be even worse if they included house prices like they did in the 1970’s and 80’s.
But there are ways to protect yourself and your buying power. Stay tuned as we discuss how you can use real estate as an inflation hedge.
Hey everyone – it’s Matt Marsh with Marsh & Partners.
Marsh & Partners is a development and national consulting firm that helps business owners and investors maximize their real estate and transform their businesses.
For a long time, we’ve been told that investing in gold and precious metals was the best solution to hedging against inflation.
But the problem is the price of gold can be easily manipulated by central banks and Wall Street.
Cryptocurrencies have recently busted onto the scene – but there’s still not a strong argument that their positively correlated with inflation.
There is, however, a tried-and-true method for hedging against inflation – and that’s through real estate.
In this video we’re going to focus on how you can use real estate as an inflation hedge to protect your buying power.
Capitalizing on short-term leases
Probably the most important aspect of real estate as a hedge against inflation is the ability to raise rents in lockstep with inflation rates or even market averages.
Properties with naturally shorter-term leases like apartments, smaller multi-family buildings, and even short-term rentals offer the owner flexibility to re-price rental rates more frequently than with longer term arrangements.
If you increase rents, assuming your mortgage stays the same, you’ll put more rental income in your pocket to cover increased expenses and management costs.
Even if you don’t own a multifamily building or a short-term rental property, you can still capitalize on increased rents through periodic rental escalators.
One of the ways you can do this is by contractually building in annual rent increases that are tied to the CPI or a predetermined set percentage.
I structure all my leases this way and advise all my clients to do the same. Every year the tenant’s rent would increase based on the prevailing escalator and the owner would be protected accordingly.
That way you can make sure that even if you’re not repricing the rental rate every year, you can at least keep pace with inflation.
Triple net (NNN) commercial leases
Commercial real estate leases uniquely offer an owner the opportunity to pass many of the expenses incurred as part of owning a property onto the tenant.
In a triple net lease, the tenant would be responsible for base rent in addition to a variety of operating expenses. This creates a hands-off investment not only from a management standpoint but protects the owner from rising expenses as well.
So even during inflationary periods when labor, utilities and input costs increase, the property owner would not be directly exposed.
Many know about the power of leverage when it comes to real estate ownership.
But fewer understand that those benefits are amplified during periods of high inflation.
Think about it in terms of your financing rate.
Let’s assume you’re paying a nominal rate of 5% on a note for a commercial property. If inflation is 8%, what does that mean for the real rate of interest you’re actually paying?
Well, if tomorrow’s dollars are worth less than dollars denominated at the time you took the note out, then you’re paying back the mortgage in fewer “real” dollars.
In other words, the real interest rate to borrow funds in this case would be negative because the nominal rate of 5% less the inflation rate of 8% is your real interest rate of -3%.
See how powerful holding debt can be when you’re using real estate as an inflation hedge?
Real estate holds intrinsic value because it’s a scarce asset.
Properties are limited to the supply of existing real estate and new development is restricted to the amount of available land.
So as monetary inflation inevitably leads to price inflation, the value of real estate will increase.
It’s also important to consider the price of inputs and commodities as they relate to real estate.
As price inflation is felt throughout the construction and materials industries, the cost to develop a new property increases.
That price increase typically translates to higher rental rates and ultimately higher real estate values for both new and existing properties.
There are some simple realities during periods of high inflation that can’t be avoided – more expensive consumer goods, increased interest rates, and higher prices for commodities.
But it’s not the time to throw your hands up and simply complain about the situation.
Instead, it’s important to think critically about how your assets are allocated. Maybe holding large amounts of cash and long-term bonds doesn’t make sense and instead you can use real estate as an inflation hedge.
If you’re concerned and want to talk about strategies, we might be able to help.
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And thanks for watching.