Hey everyone, it's John here, and today we're looking at the connection between real estate and inflation. Is real estate truly the fortress that can shield your wealth from the relentless onslaught of rising prices? Together, we'll delve deep into this question, unraveling the intricacies of this vital financial topic.
The Connection Between Real Estate and Inflation
To truly grasp the connection between real estate and inflation, we need to begin by establishing a fundamental understanding of inflation itself. At its core, inflation represents the gradual increase in the prices of goods and services over time, relative to money. You’re money effectively loses value over time. As many economists have put it time and again, when you have the same amount of money and fewer available goods and services you have too many dollars chasing too few goods the value of your dollar goes down. Similarly, when the number of goods and services stay the same, and the amount of money rises, you also have too many dollars chasing too few goods, and again the cost for goods and services rises (i.e. you need more dollars to buy the same goods and services as before). With supply chain disruptions, and a massive inflow of money printing we've seen plenty of this in recent years!
As this inflationary tide steadily advances, the value of your hard-earned money diminishes, and you find yourself in a position where you require more of it to purchase the same goods and services you once could get with less.
Now, it's time to introduce real estate into this economic equation. Real estate is a notable inflation hedge due to its intrinsic potential to appreciate over time. When property values rise, your real estate investment not only can keep pace with inflation but also potentially outperform it. Therefore, safeguarding and potentially augmenting your purchasing power. This unique characteristic of real estate makes it an attractive option for investors seeking refuge from the erosive effects of inflation.
Let's take an example. Let's say you have $300 dollars and it costs you about $3 dollars to buy a cheeseburger. Well in today's money you can happily afford to buy about 100 cheeseburgers. However, if inflation rises by 3% in the next year, then that same $300 dollars can now only afford you 97 cheeseburgers! Although you still have the same $300 dollars as before, it's real value in terms of what you can buy has actually declined quite a bit.
Now, let's say you have $300, and you decide to put that money toward buying a house. You put that money into the purchase of a house along with the rest of your downpayment. If your house increases in value by 7% in a year, the value of that $300 has now grown instead of shrinking in value over time. If we account for the 3% loss of value from inflation, and square it against your 7% increase from home appreciation you end up ahead by 4% (7% - 3% = 4%). The key take away here is this:
Instead of having your $300 remain the same amount as before and lose value over time due to the withing erosion of inflation, your money will actually gain in value helping you to retain and grow your wealth.
In nominal terms, with your $300 growing at 7% per year, that original $300 is now worth $321 one year later.
In real terms, your $300 is effectively worth $312 one year later after accounting for inflation.
In Cheeseburger terms, by investing your $300 into a home rather than staying in cash, your original $300 is now worth 104 cheeseburgers one year later, instead of the previous 100 cheeseburgers from a year ago, or the potential 97 cheeseburgers it may have become by staying in cash. In a way, buying a house is like buying a cheeseburger stand. In both cases, you're effectively investing in the opportunity to have more cheeseburgers!
While increasing your cheeseburger purchasing power by 4 burgers in a year may not seem like that much, it really adds up. Especially when you consider that you're actually ahead by 7 cheeseburgers compared to keeping your money in cash. And especially when you consider the compounding effect on larger sums of money.
Now let's look at a more realistic example. Let's say you buy a condo for $500k. You invest the minimum down payment of 5% ($25k), and your condo appreciates by 7% in one year. Now that same condo is worth $535k one year later, more than your original down payment (that's a lot of cheeseburgers!).
Benefits of Investing in Real Estate during an Inflationary Period
Investing in real estate during an inflationary period offers a range of compelling advantages that can help safeguard and enhance your financial position. Let's delve into these benefits in greater detail:
1. Appreciation:
In robust markets real estate values consistently move upward over time. This characteristic makes real estate an attractive option for preserving and growing wealth amidst inflationary pressures. Unlike some other investments that may falter in the face of rising prices, real estate assets often appreciate, allowing you to maintain the value of your investment and even see it grow.
2. Rental Income:
If you own rental properties, you have a unique advantage during inflationary periods. You have the flexibility to adjust rental rates in response to inflation. As the cost of living rises, you can incrementally increase the rents you charge your tenants. This helps you keep up with inflation and enhances your rental income and cash flow. It's like having a built-in mechanism to counter the erosive effects of rising prices. However, be aware that local rent control laws may limit your ability to adjust rental rates.
3. Leverage:
Real estate investments offer the potential for leverage, which is a financial multiplier effect. You can control a more substantial asset with a relatively modest down payment. When property values appreciate, this leverage can significantly amplify your return on investment (ROI). In essence, you're using borrowed funds to benefit from the increasing value of the property, potentially magnifying your gains. For example, let’s say you have 20% down on a $1M property. That means your down payment is $200k. In the stock market a 7% return on your investment would make you $14,000 dollars. However, in real estate a 7% appreciation on your property would get you $70k since you’re making money on the total value of the property not just your initial investment.
4. Tangible Asset:
Real estate is a tangible asset with a physical presence. You can see it, touch it, and even live in it. This tangibility imparts a profound sense of security, especially during uncertain periods of rising inflation. Unlike other investments that might feel abstract or intangible, owning real estate provides a tangible sense of ownership and control.
These benefits collectively make real estate an appealing choice for investors looking to navigate the challenges of inflation. It offers potential appreciation and provides a source of ongoing income, the ability to use leverage, and the reassurance of owning something concrete in an ever-changing financial landscape.
This multifaceted appeal underscores why many investors turn to real estate as a valuable component of their investment portfolio. Especially when inflation becomes a concern.
What to Look for When Investing in Real Estate
Investing in real estate isn't a one-size-fits-all endeavor; it necessitates carefully considering many factors. Here are some pivotal aspects to contemplate:
1. Location, Location, Location:
The time-honored real estate mantra remains as relevant as ever. The geographic location of a property can dramatically impact its potential for appreciation and income generation.
2. Property Type:
Different property types, such as residential, commercial, or industrial, present distinct risk and return profiles. Your investment objectives should align with the property type you choose.
3. Market Conditions:
Staying well-informed about local and national real estate market trends is imperative for making prudent investment decisions.
4. Cash Flow Potential versus Appreciation:
For investors who prioritize income generation, securing properties that yield positive cash flow is paramount. However, other investors may be less interested in cashflow potential and more focused on appreciation potential over time.
5. Long-Term Viability:
Assess the property's potential for sustained appreciation and income generation over the long term. A well-considered investment should have enduring value.
Strategies for Creating a Secure Real Estate Portfolio Hedge
Constructing a robust real estate portfolio to safeguard against inflation requires strategic planning and a comprehensive market understanding. Here are some strategies to consider:
1. High Cash Flow Real Estate:
Investing in properties that generate substantial rental income relative to their expenses can provide a dependable income stream to counteract the erosive effects of inflation. Even if you choose to focus more on appreciation than cashflow, it's still a good idea to invest in rental properties where the cashflow can at least cover all of your rental property expenses.
2. Investing in Debt:
Some investors invest in mortgage debt or real estate-backed securities. While they might not own the property outright, they can benefit from interest payments and potential appreciation.
3. Networking:
Cultivating a robust network within the real estate industry is invaluable. Collaborating with other investors, real estate professionals, and experts can provide useful insights and uncover unique investment opportunities.
Wrapping Up
In conclusion, real estate undoubtedly serves as a potent hedge against inflation due to its potential for appreciation, rental income generation, and the ability to leverage your investment capital. Nevertheless, it is not a guaranteed safeguard; success in real estate investment demands a multifaceted approach.
Investing in real estate requires a meticulous consideration of every critical factor including location, property type, market conditions, cash flow potential, and long-term viability. Constructing a secure portfolio involves:
Diversifying investments.
Exploring high cash flow opportunities.
Harnessing the power of networking
Analyzing every opportunity
Developing a plan to manage risk
In the ever-evolving landscape of personal finance and investment, staying well-informed and adaptable is critical. While real estate can be a formidable component of your investment strategy, it should be part of a comprehensive, well-thought-out plan.
So, stay curious, stay vigilant, and remember that the path to financial security is an ongoing journey. Until next time, may your real estate investments thrive, and may your wealth remain resilient in the face of inflation!
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I am a Victoria-based local realtor with eXp Realty. My commitment to honesty, integrity, loyalty, and hard work have been essential pillars for me because they drive a high standard of excellent service for my clients. Helping you realize your dream is my goal!
I service Vancouver Island, but my focus is on Victoria, Sooke, Saanich, Malahat, Shawnigan Lake, Cobble Hill, Duncan, and the rest of the Cowichan Valley.
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