Inflation is when the purchasing power of your dollar decreases. And while the effect of inflation is immediately recognizable at the grocery store and the gas pump, you may be wondering how inflation affects real estate, especially if you’re a real estate investor.

How Does Inflation Affect Real Estate

  1. High Lumber Prices
  2. Rent Increases
  3. Higher Mortgage Rates
  4. Existing Real Estate is More Valuable
  5. REITs Returns Rise

Nothing exists in a bubble anymore. The global supply chain and the economic systems that support it are extremely interconnected. This means that when the purchasing power of the U.S. dollar decreases, it affects a number of different areas, including the real estate prices and other related factors in the housing market. This, in turn, impacts everyone, including buyers, renters, investors, property managers, and contractors.

Inflation is often caused when an oversupply of money floods into the marketplace. Sometimes it can also be triggered by an acute event, like a war or famine. And sometimes it’s triggered when the Federal Reserve lowers interest rates to stimulate lots of borrowing, which puts more money into the economy. Per the laws of supply and demand, as money increases, its value decreases. And as its value decreases, this means that suppliers of goods and services must raise prices to keep up with costs and recoup the losses they face from receiving currency with reduced purchasing power.

But if you’re someone who has already been participating in the housing market—whether that’s through a rental property portfolio or buying and selling homes—you know that a good investor or entrepreneur seeks out opportunities in both good times and bad. The rising inflation rate we’re seeing in the North America bodes poorly for economic growth as consumers find themselves with less purchasing power. But higher inflation can also mean higher housing prices and rent prices. For a property owner, the inflation hedge of real estate can translate into some real returns from real assets.

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 How Does Inflation Affect Real Estate

There are a number of ways high inflation can affect the real estate market, including:

1. High Lumber Prices

Nearly every residential dwelling is built with timber framing, with the exception of large multifamily housing, such as an apartment or condominium tower. High inflation, once again, means that the purchasing power of the dollar is down, which means that goods and services cost more.

In this case, the basic commodity of lumber sees an increase in prices. As it relates to today, this increase in lumber prices was also recently attributable to the supply chain crises caused by the Covid Pandemic. As supply chains shut down or became severely impacted by quarantines, suppliers experienced backups and deliveries fell short of expected quantities, making the price of lumber skyrocket.

Prices had just started to come down again, but now inflation will see them rising once more. This doesn’t just impact builders and contractors. It can also impact homebuyers and investors who are going to have to pay more for new construction they are buying or financing.

As it turns out, there is a silver lining to this cloud if you invest during inflation. Lumber, like many other raw materials, is a great investment during inflation because prices of these commodities tend to skyrocket.
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2. Rent Increases

Another factor to consider is that inflation is likely going to lead to a rent increase. If you’re a renter, this is bad news. Your property manager or landlord is going to need to raise rent in order to compensate for rising costs, like maintenance, property management, and materials. They may even need to compensate for rising interest rates on properties that aren’t locked into fixed mortgages.

If you’re a landlord, this isn’t necessarily bad news. You can pass these increased costs onto renters while taking advantage of opportunities for increasing profits. Keep in mind, however, that many municipalities and states have specific landlord tenant laws around rent increases that will prevent you from increasing the rent beyond a certain percentage or accelerating that increase beyond a certain rate. There is also the concern that during an inflationary period, some of your renters may have difficulty paying rent on time or in full. Even so, real estate is generally going to provide solid cash flow no matter the economy, making it one of the best low risk investments.

3. Higher Mortgage Rates

You have probably heard that banks will lower interest rates during a recession to stimulate borrowing. Inflation, however, is a different story. Inflation reduces the purchasing power of the dollar. This in turn leads to securities that are connected to the dollar to fall in price as well, including mortgage-backed bonds. This leads to investors (namely large institutional investors) selling off their bonds, leading to an oversupply of mortgage-backed bonds (also known as mortgage backed securities) on the market, leading to a decrease in value (more supply, less demand, lower value). As bond prices fall, their yield rises. Because mortgage interest rates are tied to these yields, the rates increase, which is bad news for homebuyers searching for a new home.

Higher mortgage rates make purchasing a home more expensive, which forces a lot of people to continue renting. For existing homeowners, however, this might not be such a bad thing if they are locked into a fixed rate mortgage. If you’re a real estate investor just looking to get started, this might seem like a deterring factor, but there are plenty of ways to learn how to invest in real estate with no money.

4. Existing Real Estate is More Valuable

Imagine you are playing Monopoly, and there are 20 little houses on the market, with a fixed monetary supply of $20. Now imagine that we add $20 to the money supply. The amount of money in the market has doubled, but the housing supply has stayed the same. Now, every little plastic house is potentially worth double as well. While this example is extremely simplistic, in broad strokes, it illustrates what can happen to a home price during an inflationary period when the market is flooded with money.

The downside to this scenario is that the rising cost of goods and increased mortgage rates might make home buying more difficult for many consumers. This might not be such a bad thing, though. Consumers who are still able to become homebuyers are placed in a marketplace with increasing home values, and will have to present attractive offers to current owners. If you’re selling your own home, this can work to your advantage. And if you’re a real estate investor who is flipping homes, this will also work to your advantage.

It’s factors like this that are among the many to be considered if you want to start investing in real estate. Learn more in our weekly Real Estate Investing Room.

5. REITs Returns Rise

If you don’t want to master the ins and outs of real estate funding, a real estate investment trust (REIT) is an attractive option. REITs are sort of like mutual funds, in that investors pool their contributions together to purchase residential and commercial real estate to build a managed portfolio.

Most REITs only require minimal contributions of $500 or $1,000 to start participating. They also offer decent rates of growth, often around 8-12%. Additionally, they often provide dividends from retinal income. Taking into consideration several of the factors we have mentioned, including rent rising housing prices, this means the total returns of a REIT can be very profitable.

Is Inflation Good or Bad for Real Estate?

It really depends on how you’re involved in the real estate market. If you’re a renter, it’s not good. If you’re a landlord, it can be a positive thing, both in terms of collecting more rent and in terms of property values increasing. If you’re a homeowner, it could mean getting more money for your property if you’re looking to sell, all while enjoying the lower fixed interest rate your mortgage is locked into. If you’re a potential homebuyer, though, it’s not good; you’ll be looking at higher interest rates and a competitive sellers’ market.

The truth is that even each of these options can become more complicated depending on the details. A renter facing higher rents may not mind as much if they have lots of money invested in REITs that are swelling. A landlord may not be happy if inflation means tenants are paying the rent late because they can barely afford gas and groceries.

As you can see, it really depends on each person’s situation. But one thing is certain: if you have cash invested in a real estate asset class, it will prove to be a good hedge against the decreasing purchasing power of the dollar.

Real Estate Inflation Can Cause Costs to Rise, But There Are Ways to Hedge Against It

Depending on your situation, rising inflation in real estate can be a boon or a bust. If you’re a first-time homebuyer or a renter living on a fixed income, then the rising home prices will not work in your favor.

But if you’re sitting on a portfolio of existing properties, you will likely see your property value go up. Which not only means will you be able to sell existing properties for more (if you so choose), but it’s also an opportunity to re-evaluate your rental pricing to ensure your properties continue producing a profit. And while some of your maintenance costs may go up, if you’re locked into a fixed rate loan, you’ll be insulated from most of the consequences of inflation.

As you can see, investing in real estate is an excellent way to hedge against rising inflation. To learn more about the best strategies for adding real estate to your investment portfolio, including access to our team of investing experts, sign up for a free Infinity Investing membership.

Bonus Video

Infinity Investing Featured Event

In this FREE event you’ll discover how the top 1% use little-known “compounders” to grow & protect their reserves. Our Infinity team of experts show you how to be the best possible steward of your finances and how to make your money and investments work for you instead of you working for them. Regardless of your financial situation today, you’ll have a road map to get to where you want to be.