Active investors keep an eye on their money, the economy, and on what’s happening on Wall Street. One question that is often asked—is real estate a good hedge against inflation?
Understanding what is a “hedge” and how inflation works will help explain why hedges, and in particular, a real estate inflation hedge, might work for many investors.
What is a “Hedge” in Investing
So much of what happens in the U.S. and abroad can hurt consumers and investors. Rising prices, economic downturns, natural disasters, and inflation can create great uncertainty—real and imagined—in the economy. At times, it feels as if the U.S. is just one more negative consumer confidence or jobs report away from complete disaster.
Including tangible assets in your portfolio is a way of offsetting these disturbances. These types of investments are considered “hedges,” because they are less exposed to the rise of inflation and other negative events. Hedges help protect the value of investment dollars.
Hedges can include gold, bonds, commodities, and real estate. There are other types of hedges investors can use as well. Some of these include more complex financial instruments such as derivatives for example.
For the purposes here, we want to simply understand what a hedge is and to later understand how the real estate investment hedge is a possible play for many active investors.
Investopedia uses this simple explanation to describe hedging:
The best way to understand hedging is to think of it as a form of insurance. When people decide to hedge, they are insuring themselves against a negative event’s impact on their finances.
Source: Investopedia
One of these negative events, inflation, is one every investor should understand. And finding out why is real estate a good hedge against inflation can provide investors with another tool in their toolbox to protect their wealth.
But what is inflation and why should we care about it?
Inflation 101
Inflation is the rate of rising prices for goods and services. This rise in prices can occur in different ways.
Raw Materials
An increase in the price of steel from China, can put pressure on consumer pricing. Manufacturers absorb and then pass on those rising material costs down through their distribution chain. As a result, distributors pay more, retailers pay more, and ultimately the buying public pays more. Those raw material costs don’t happen in a bubble, they affect everyone.
Increasing Wages
If employers need to pay more for workers, this can create a rise of inflation. As a business’s payroll increases, the company needs to find ways to remain profitable. One obvious action they might take? You guessed it—they raise prices on their goods or services, and the consumer feels it in the wallet.
High Demand
Consumers might want something so badly they’re willing to pay higher prices. A demand for necessities such as food, housing, or gas can drive up prices as those items become scarcer.
Case in point: think about the demand for housing right now. A scarcity of available homes created buying frenzies in many parts of the country, where buyers overspent on the price of homes in sometimes dramatic fashion.
Excessive buying can lead to product shortages and rising prices
The Effect of Inflation
Inflation erodes the value of the dollar, affecting consumers ability to buy goods and services. With the U.S. dollar worth less, consumers are forced to spend more. This can set off a chain of events that impacts the economy at large.
Because of its effects on the dollar, this in turn impacts your rate of return on your investments.
For example, if your investments generate a 7% return, but inflation is at 5%, your net gain is only 2%. In this scenario, your investments are not keeping pace with inflation. The investor is essentially losing money to inflation.
Not So-Fun Fact: If a 5% rate of inflation sounds high, you’re right. But this is exactly what is happening right now as inflation is at its highest rate (5.25%) in 30 years!
Enter the Fed
Part of the Federal Reserve’s job is to watch and react to the ebb and flow of inflation. The Fed wants to keep inflation at the 2% mark and makes policy adjustments to keep prices from increasing too much or too quickly.
They understand what the trickle-down effect is when inflation rages out of control. Things become more expensive, companies lay off employees, and the larger economy struggles.
Historical Rise of Home Prices
Home prices follow a similar historical trend in comparison to the growth of inflation. Though at times the housing sector has taken steep downturns, generally home price values keep up and typically beat the rate of inflation.
Source Data: Federal Reserve Economic Data (FRED) and MacroTrends
Advantages of Having Money in Real Estate
- Over time a property owner lowers their home’s Loan to Value. As an owner pays down the mortgage, for example, this builds equity.
- Home values have historically grown over time. As home values rise, equity in the property also increases.
- Inflation rises slowly. This steady, but slow rise over time makes it easier for properties to hold their value.
The Real Estate Inflation Hedge
Every investor wants some level of stable investments to round out their diversified investment portfolio. Stocks and bonds can fluctuate widely, so having a hedge strategy in place can help you sleep at night.
You can begin investing in real estate today without the hassles of fixing and flipping or acting as a landlord.
Secured Investment Corp.’s Fund III allows investors to invest in real estate at a very low cost. This fund is fully audited by Verivest and only requires an initial investment of $1000.
Click to receive the Fund III Infopak for FREE and learn more about investing in real estate.
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