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Real estate is an excellent opportunity for those looking to diversify their investment portfolio or get into a new investment that provides a bit more security and lacks the high volatility often experienced by the stock market.
Investors are concerned with inflation skyrocketing and interest rates seeing a hike. This concern is understandable, but real estate is still a solid investment opportunity for those in the know.
We’re going to explore how rising inflation and interest rates affect multifamily real estate investments in this article by going through all the affecting circumstances and factors. By the end of this article, you’ll have a firm grasp of what inflation is and how it affects the real estate market so you can feel secure in your investments.
Related: As Stock Markets Devalue, Real Estate Stands as a Safer Investment Track
Inflation Explained
The word ‘inflation’ gets thrown around a lot, but many people don’t have a proper understanding of what it means. Generally speaking, inflation is an increase in the cost of goods and services. Most people understand that inflation lowers the buying power of a dollar.
A loaf of bread may have cost $0.23 in 1960, but today the average cost is closer to $1.69. This can seem like a significant price hike, but when accounting for inflation, the price is comparable.
The loaf of bread comparison is a minor example of how inflation naturally compounds overtime and changes the price of general goods and services. Normally, inflation grows organically and the increase in costs happens slowly overtime.
However, there are periods of time where inflation spikes beyond what’s considered normal. In these instances, it can have a significant impact on the economy.
There are a couple of ways that inflation can happen, but regardless of its cause, inflation results in increased prices and decreased dollar buying power.
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What Causes Inflation and How Is it Managed?
Inflation can happen in one of two ways. It can result from an expanding economy, where the abundance of money available outweighs the number of goods and services available for purchase. This creates a sense of scarcity, which drives up prices.
When there’s an increase in the supply of money available that is put back into the economy quickly enough, this can also cause inflation.
Whether inflation is caused by an expanding economy or a supply shortage of goods, the Federal government has systems in place to help manage it and prevent it from rising too high.
The government manages inflation by changing interest rates. The Federal Reserve will raise interest rates when inflation gets too high. This works to slow the economy and will lead to lower inflation. Similarly, the Federal Reserve will lower interest rates when inflation gets too low. Doing so will stimulate the economy so more money is spent, and the economy could grow again.
There is a rule that was developed by economist John Taylor in 1993. It’s often referred to as the Taylor Rule or the Taylor principle, and it ties a central bank’s policy rate to economic growth and inflation. Generally speaking, the Taylor rule recommends that interest rates rise 1.5 times as much as inflation.
Related: The State of Multi-Family Real Estate Investments in 2022
Inflation’s Effect on Multifamily Real Estate Investments
Historically, the government has set the inflation target at 2%. It hasn’t risen above this percentage since the Great Depression in the 1930s. However, due to the COVID pandemic’s effect on the economy, the government has decided to allow inflation to surpass 2%.
The effect of this on the economy will play out over the next several years. However, there are already noticeable changes when it comes to inflation’s impact on multifamily real estate investments.
As inflation goes up, so do interest rates. The price of buying a home has increased, leading to difficulties for first-time home buyers in particular. As more people struggle to secure a home, it leads to extended time renting properties.
As more people look for stable housing, they often turn to multifamily properties. As the demand for rental properties increases, this allows property owners the opportunity to increase their revenue.
Rental prices have steadily increased at a rate of 2% each year since 2012. Now that we’re halfway through 2022, that percentage has increased to 3.7%. This shows that despite rising inflation and interest rates, real estate is still pulling in significant revenue and remains a secure investment.
Multifamily real estate properties are an excellent investment because they’re physical properties with intrinsic value. Not only do their profits generated from rent and other fees go up as inflation rises, but the value of the property itself will rise.
Related: What is “Liquidity” in Real Estate and When Is It Needed?
Can Multifamily Assets Hedge Against Inflation?
Multifamily investments can be a hedge against inflation. While prices rise and more money is needed to pay everyday expenses, multifamily properties can still generate a significant increasing income.
Rent and other related fees often increase during inflationary times, and these sources of revenue have the potential to outpace the effect of inflation. This makes multifamily properties very advantageous for investors.
Aside from the revenue from tenants, multifamily properties are also likely to increase in appreciation as inflation increases. The same effect due to inflation that limits potential home buyers can benefit investors because the value of homes will increase during inflationary periods.
Another factor contributing to multifamily assets hedging against inflation is the debts secured by these properties. Often, the type of loan secured by a multifamily property is long-term and fixed-rate.
This allows the debt to remain stable even during periods of inflation. So, as prices rise and the value of a dollar decreases, the debt will not increase as daily goods and services do.
Having a fixed-rate loan with the potential for multiple revenue sources through rent, pet fees, parking fees, etc., gives multifamily properties a unique opportunity to survive and thrive during inflationary periods.
Conclusion
Inflation drives up the prices of most goods and services while decreasing the purchasing power of a dollar. This can spell trouble for many businesses and investments, but multifamily real estate has a unique opportunity to thrive during times of inflation. Rental prices and the appreciation of the property are likely to increase as a result of inflation, and this can lead to a substantial payoff for property owners and investors alike.
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