With inflation reaching levels not seen in decades, real estate remains an attractive investment option. Inflation has been a top concern for investors for several months and it doesn’t look to be going away any time soon. Real estate has always been a strong alternative to the stock market when inflation kicks in.
As the Federal Reserve begins increasing interest rates to combat inflation one remaining question is how many times will interest rates rise over the next 12 to 18 months? At least three rate bumps are likely in the near future with possibilities going as high as six increases. As the first one or two rate bumps take effect, the impact will be minimal because we are just coming off historic lows - getting back to normal. It’s the longer term that will have a more profound effect on the overall economy - after all, rising rates lead to higher financing costs, making it more expensive for buyers to purchase and owners to refinance.
Affordability to purchase a home has been a problem for a couple of years. People buying their first home have always struggled - but that demand will continue. What is changing with inflation is that prices for everything else are now moving in the same direction as home prices. The stock market suffers when inflation is sustained above 2% because the cost of consumer goods leads to lower demand. People buy discounted products, lower quality products, and substitute alternative products. For instance, staycations are likely to be substituted for vacations as gas prices skyrocket. Business profits will go down, which means stock values decline when all other costs are going higher.
Higher consumer costs also mean higher costs to build new homes. Lumber prices have been high for years and are hitting new highs each month. Adding to this is a broken supply chain for other building materials that doesn’t look to improve anytime soon.
Now add to that the fact that real estate is a limited commodity. No one is creating any new raw land. Real estate is always local, which is why land values vary dramatically between urban and rural settings. Inflationary prices will be sustained particularly in dense, urban neighborhoods, where there is a limited supply of properties, and a lack of available land to build new structures on. This is good news for current property owners, as demand for real estate does not generally decrease, even when inflation rises. In fact, property values are almost certain to increase, given the rising cost of materials and labor to build a comparable structure.
Housing is a necessity. As inflation continues, consumers will trim the fat from more discretionary spending like travel, clothing, and entertainment to make more room for necessities like housing. That fat cutting is what has the stock markets spooked.
Conversely, inflation is now eating away at the real estate bubble that some people feared. Home prices are moving back in line with consumer costs. Home prices do remain out of reach for some people but there are economic trends to keep many people in the home buying game. The fact that there have been bidding wars means that there are still buyers on the sidelines with a healthy chunk of money saved towards a down payment. Between the economic stimulus checks and money saved due to COVID restrictions, it’s estimated that Americans are sitting on an extra $2 trillion. Unemployment is almost nonexistent with employers ready to hire on the spot. Between inflation and nearly full employment, further wage increases are coming in the near future. People will still be able to afford mortgages at higher interest rates.
With inflation and economic recovery acting as counter-forces, bidding wars should go away, and price appreciation should fall in line with inflation rather than reaching for the stars. Real estate has about a 100-year history of keeping pace with inflation. In big metropolises, house prices outpace inflation due to the concentration of work opportunities, but in more rural areas, home prices stay at pace with inflation.
Residential housing will do better than commercial real estate. Commercial properties have longer lease periods when it comes to office buildings, warehouses, and other long-term real estate. Rents for these properties have a harder time keeping up with inflation. And the pandemic created a rise in remote work and online shopping that lowered demand for retail and office spaces.
Single-family and multifamily housing is a different story. These leases typically come up for renewal every 12 months. Not only is it easier for landlords to increase unit rents to keep pace with inflation, but multifamily landlords can do the same to keep pace for shared costs such as utilities and maintenance.
Overall, residential real estate can be expected to outperform during these inflationary times. For investors in stocks, this may be an opportune time to consider rebalancing your portfolio towards real estate. With the Federal Reserve’s planned interest rate hikes, the sooner the better. The same goes for any current homeowners looking to refinance.
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