“Invest in inflation. It’s the only thing going up.” -
Will Rogers

Recently, we have had an enormous number of discussions surrounding the US economy and its current inflation. One thing we do know is that “inflation is here,” and it appears that there are no near-term signs of stopping.

The Consumer Price Index (“CPI”), the most common index to measure inflation, reached 283.716 points in February 2022, nearly 8% higher than in February 2021 – the largest year-over-year increase in 40 years.

But what does that really mean for multifamily real estate investors in the US?

Historically, many financial experts and academics have recommended real estate as a hedge (or a source of financial protection) against inflation. If you’ve invested in the real estate market lately, you have most likely felt some of the forces of inflation. If not, I am sure many of you have heard a story or two from your family, friends, or network.

Since no one can say they’re quite certain about the future, it’s important for our audience to understand: 1) inflation; 2) how it works; 3) how it affects your current and/or future real estate investments; and 4) the best ways to protect your financial health and portfolio of investment assets.

What Is Inflation?

Inflation is essentially the rise in prices of goods and services within an economy over a set period of time (one-year or year-over-year is most commonly used).

To paint this picture simply, here’s an example

· Over the long-term we are usually experiencing an average annual rate of inflation of 1.8%. Let’s say you bought a microwave for $400 last year at this time, you would need to pay an additional $7.20 for the same cooker today.

· With today’s inflation we are looking at 7.9%., so instead of $7.20 additional from the average 1.8% you would now pay $31.60 more (a $24.40 difference).

It might not seem like a lot of money to be worried about in this case. However, after adding up all your bills for the year, like internet, gas, groceries, phone bills, and other expenses, you actually end up spending a lot more.

In terms of purchasing power this means a dollar buys less over time.

For example, since 1913, the US dollar’s purchasing power has declined by roughly 96.5%. If you had $1 a century ago, it would only be worth about 3.5 cents today

Some people confuse inflation with appreciation. The two are different.

1) Appreciation in real estate refers to the rate at which a property’s value goes up over time.

2) The increase in value in appreciation isn’t due to inflation. The value appreciates due to the rise in demand and underlying fundamentals of the asset.

It’s common to see the value of property increasing at a higher rate than inflation, but can also increase at a slower rate, or perhaps even depreciate, as the economy experiences inflation.

What Causes Inflation?

We made a short list of some of the important (and currently relevant) causes of inflation for you all:

· Lax monetary policy - This is also known as money printing. It increases the amount of money in circulation, which, in turn, results in the decline of the currency value. The US government provided a $5 trillion stimulus during the pandemic, which was the largest amount of money ever distributed in US inflation history. To put this in perspective, this amount is 3x the amount after the financial crisis in 2008.

· Expecting prices to rise - Based on knowledge of the experts, expectations of rising prices eventually become self-fulfilling. When businesses expect prices to increase, they also adjust their prices. This is when you find rent prices increasing or see real estate investment firms directing their property managers to negotiate wages of the property staff.

· Supply Shocks - Supply shocks happen when there’s a rise in prices due to an increase in demand but a low supply. It happens when there are natural disasters or business lockdowns.

· Demand Shocks - Demand shocks include when you find real estate investors engaging in bidding wars to purchase investment properties with the potential to yield rental income.

(View our past discussion on navigating the market cycle)

How Does Inflation Impact Real Estate Investors?

While inflation can look like a negative thing, it’s not entirely so – believe it or not, there are some positives. Let’s break down this section into what inflation means for current and prospective real estate investors.

Inflation for (Current) Investors

One case is if an investor or investment firm has financing to invest in property as a leveraged asset while interest rates were low (and in the meantime still are, relatively speaking). Depending on the type of financing, the investor could be paying back the same rate while the investment property appreciates in value.

(View our past discussion on interest rates)

In the current inflationary environment, financing (i.e. interest) rates aren’t rising at the same rate as the inflation. Given a sale, this means that an investor’s return on investment could soar.

Inflation for Prospective Investors

Based on historical data, prospective investors could potentially experience the most negative effects in an inflationary market.

· Inflationary times lead to high costs of borrowing. Since banks and lenders don’t want to lose their money, they offer fewer loans at high interest rates to reduce their risk.

· Inflationary times lead to a high cost of building. Due to the high cost of borrowing and building materials, new constructions or larger renovations during inflationary periods could make for a difficult investment.

With that said, this would not be the case for every prospective investor. In fact, there are always ways to find hidden value and participate in the market as a contrarian.

(View our past posts on: identifying hidden value & contrarianism)

How Does Inflation Impact the Real Estate Prices?

Some are expecting real estate prices to continue rising into the double digits over the next year.

So how about we answer the question, “what are the causes of the real estate price increases during inflation periods?”

1) Demand in Income Generating Assets

One of the major reasons why real estate prices increase during inflation times is because real estate investors search for assets that will generate rental income that keeps up with or outpaces the current inflation rate.

Rental income is the money collected from the tenants and used to settle property operating expenses, taxes, and mortgages. Any money that remains after settling the expenses is the net cash flow. In this case, we express the rate of return as the cash-on-cash return. . Cash-on-cash return measures the amount of cash flow relative to the amount of cash originally invested in a property. As inflation increases over time the inflated income dollars collected measured against the original investment amount should help to boost this cash-on-cash return.

2) Limited Real Estate Inventory

Real estate prices during inflationary periods also go up because of the limited amount of real estate compared to fiat currency. You’ll find governments printing more money during such periods to increase the money supply.

This can cause real estate prices to rise.

3) Increase in Construction and Renovation Costs

Inflation tends to cause all prices to increase, including land, wages, building materials, and supplies.

As a result, home builders and multifamily property developers pass the cost of construction to home buyers and investors, which we are currently seeing in the market today.

· Over the past 12 months, building material prices have risen by over 19%, including lumber, ready-mix concrete, and boards used for finishing ceilings and walls.

(View our past discussion on capital expenditures)

So, what’s the remedy for real estate investors during inflation?

What Should Real Estate Investors Do During Inflation Periods?

Ask yourself: how long would you like to (or intend to) own the prospective investment property?

If you want to keep it in the long term, you can expect to enjoy the same benefits as existing owners, such as property value appreciation. If you’re looking to invest in a much shorter period, we advise you to proceed with a lot of caution.

One major danger of investing in the short-term during inflation is that the potential risk of a real estate bubble. If you are a new direct investor, if you don’t have enough equity to settle such costs, then you may lose a lot of money should the bubble burst.

Book a meeting with the CF Capital team today to learn more about how we can help you navigate inflation with multifamily real estate investing utilizing our tools expertise.

Recently, property prices have risen to historic levels. While the trend may not cause concern, it emphasizes the importance of understanding your investment time horizon and planning accordingly. For CF Capital, we are spending more time than you can even imagine to make sure we are being as thoughtful as possible with our Business Plan. (View our past discussion on our Business Plan)

How Can Investors Use Investment Property as an Inflation Hedge?

Investing in real estate during inflationary periods always depends on the location and the state of the market. However, investors may use the following ways to gain a hedge (i.e. protect their investment portfolio) against inflation:

· Invest in Multifamily properties: Since many people can’t afford to build their own homes during inflation, multifamily rental properties tend to have a higher demand. As a real estate investor, you can then hedge against inflation by controlling the revenue levers available in the marketplace as a result. For those looking to gain exposure without the hassle of managing a property, please feel free to reach out to us – we can discuss our current or potential upcoming investment offerings OR just guide you to the right path that you are looking for. Either way, we would be more than happy to have a conversation. (CLICK HERE to fill out our inquiry form)

· Leverage historically low financing: Interest rates for real estate financing reached historical lows, and still remain quite low in relative terms. A real estate investor can take advantage of the low-interest-rate environment to steer clear of paying higher rates in the future.

· Capitalize on rising asset values: History has demonstrated that real estate investors benefit from owning properties in the long term. For example, since 1990, median home prices have risen by 345%. Similarly, property prices have increased by nearly 20% since 2020. It is another reason to justify using real estate as a hedge against inflation.

It’s essential for you to have funds available so that you can seize any available opportunities. As we always advise, make sure you carry out your due diligence since investing during inflation periods can go either way. If you do not have the capacity or do not feel comfortable in your due diligence, we would be more than happy to discuss what we do!

(View past discussion on due diligence checklists)

What’s Next for Real Estate Investors?

The bursting of the 2008 real estate bubble and consecutive economic recession still haunts investors, buyers, and sellers to date.

Please note that while prices continue to go up, it’s difficult to predict a market decline. On top of our lack of interest in speculation, there’s still insufficient data to suggest that a recession is imminent.

The current market inflation is quite different from what we experienced just before the Global Financial Crisis. Though there’s a short supply of labor, the economy is growing at a steady rate, and the rate of unemployment is on a decline.

We remain optimistic that the post-pandemic economy will fully reopen and grow to provide more opportunities.

Remember to always do your due diligence. Smart planning and time management will help you manage your economic risk.

Finally, we recommend that you speak to your financial advisor or a real estate investment firm, like CF Capital, so you can find the best way to invest in a multifamily property.

Main Takeaways

· Real estate prices tend to increase during periods of inflation due to the excess money in circulation in the economy.

· Many investors have used real estate as a hedge against inflationary periods.

· You can use multifamily real estate investment to generate income above the inflation rate while also capitalizing on the potential property value appreciation in the long term.

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