Inflation is a silent adversary in the financial world, gradually eroding the purchasing power of your hard-earned money. As traditional investments like cash savings and bonds fall prey to its effects, savvy investors are constantly on the lookout for more viable options that can effectively combat inflation. One such option, steeped in historical precedence and tangible value, is real estate. But is investing in property truly a reliable hedge against inflation, or is it fraught with unseen risks? Read on to learn more about the pros and cons of this strategy.

Join us to have information like this delivered to your inbox. 

The Inflation-Real Estate Connection

Real estate has long been touted as a hedge against inflation, as the intrinsic value of property tends to rise alongside the general increase in prices. This notion is supported by a few key factors.

The Value of Physical Assets

Real estate is a physical asset, meaning it maintains intrinsic value that tends to rise with inflation rather than depreciate. As the costs of goods, labor, and materials increase, so does the replacement value of properties. This helps preserve and even bolster the property’s worth over time. 

The Flexibility of Rental Income

Rental income provides a consistent stream of revenue that typically adjusts for inflation. Landlords can increase rent to match the cost of living, counteracting inflation’s impact on purchasing power. In doing so, they preserve their income’s real value.

The Power of Appreciation

Because real estate appreciates over time, it does a fine job of outpacing inflation rates, especially in high-demand locations. Property values rise alongside the cost of goods, providing capital gains when owners sell and creating a hedge against inflation by combining steady income with long-term value growth. 

Potential Risks and Considerations

Real estate is a good hedge against inflation, but before running out and purchasing property, it’s important to weigh some of the potential drawbacks.

Market Volatility

Market volatility can cause property values to fluctuate, particularly in areas that are heavily influenced by economic cycles. While property values generally appreciate over time, downturns can result in periods of declining or stagnating prices. This, in turn, can delay or reduce returns.

Investment Costs

The upfront costs of investing in real estate can be a turn-off to those with limited funds. Expect to pay up to $50,000 for a single-family home rental, as well as closing fees and agent commissions. Be sure to also consider ongoing maintenance costs, property taxes, and insurance. It really adds up!

Illiquidity

Illiquidity is a major drawback in real estate investment. Unlike stocks and bonds, real estate cannot be easily converted to cash without costs and delays. This can be problematic in an emergency or if an investor needs to quickly access funds, which is not uncommon during periods of inflation.

Leverage Risk

Leverage risk poses some serious challenges. Inflation usually leads to rising interest rates as central banks aim to control economic overheating. For leveraged real estate investors, this means that mortgage rates on new loans, or adjustable rates on existing ones, may increase alongside inflation. As a result, borrowing costs rise just when investors may be counting on real estate to offset inflationary pressures. 

How to Maximize Real Estate as a Hedge Against Inflation

Despite its drawbacks, real estate remains an incredibly effective buffer against inflation. But in order to take full advantage of this strategy, it’s important to keep a few critical tips in mind.

Diversify Your Portfolio

Building a diversified portfolio is one of the best ways to hedge real estate against inflation. Instead of putting all your eggs in one basket, consider spreading investments across multiple properties such as residential, commercial, or even farmland. This reduces the risk of sector-specific downturns. 

Leverage Smartly

Leveraging is when you use borrowed capital to finance real estate investments, acquiring more property than you could with cash alone. Real estate tends to increase in value over time, especially during inflationary periods when rents and property values rise. By using leverage the right way, investors can amplify their potential returns without fully tying up their own funds.

Keep a Long-Term Perspective

If you want to invest in real estate, you need to be okay with the fact that it could take years, if not decades to see substantial returns. On average, those seeking to “get rich” through real estate should plan on waiting 15 or more years to see the big bucks roll in. 

During times of inflation, the cost of materials and labor tends to rise, increasing property values. This gradual appreciation favors investors who are willing to play the long game and hold onto properties for extended periods.

Conducting thorough market research and staying abreast of economic trends can empower investors to make informed decisions, ensuring their portfolio remains resilient in the face of inflationary pressures.

Real Estate: A Reliable, But Not-Impenetrable Hedge Against Inflation

Investing in real estate is an extremely effective strategy for weathering the storms of inflation, but it’s hardly a panacea. To maximize hedging while minimizing risk, be sure to follow the tips outlined here, and consider speaking to a financial advisor to develop a plan that’s tailored to your investing goals.

To have information like this delivered to your inbox, consider joining us. 

 

Founded in 2010, our services include boutique hedge funds, separately managed accounts, financial planning, estate & trust services, private placements, life insurance and annuities, and in-house concierge services for high-net-worth individuals, families, and businesses. To find out more about our services or reach a registered investment advisor, please fill out the Contact form.

 

PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. All investments involve risk, including the loss of principal.