As inflation reaches its highest point in over 41 years, there's a growing need for investors to inflation-proof their portfolios. But right now the stock market is down 20%, causing many investors to look elsewhere for a hedge against inflation.
Real estate is a long-proven method for combating inflation, but not all real estate investments are created equal. If you're looking to outpace inflation, here's one particular real estate trend that could be the perfect solution.
Cash flow is king
There are loads of ways to invest in real estate, including flipping homes, wholesaling properties, and even buying or selling mortgage notes. But none offer the same kind of inflation hedge as cash-flowing real estate. Rental property, particularly residential real estate, can be a fantastic investment in high-inflation times because real estate values usually increase as inflation rises while also offering the ability to earn cash flow. Additionally, it's especially helpful to be able to adjust rental prices when property taxes, insurance rates, and the costs of goods and services all increase.
Rental rates typically grow with inflation, just like real estate value. Landlords can adjust rents at times when property taxes, insurance rates, and the costs of goods and services all increase. This means that despite the higher costs of operating and owning the rental, property owners can still generate a positive return.
However, recessionary periods can result in less rental demand, lower rental rates, and higher vacancies -- all of which can make combating inflation challenging. Low cash flow margins, meaning there isn't much money left over each month after expenses are paid, could leave investors footing the bill for owning and managing the rental in a high inflation or recessionary period.
Why fixed-rate mortgages are magic
Variable expenses are heavily impacted during inflationary periods. That is the reason why the costs of things like food, fuel, and energy have risen so much over the last year. Therefore, having fixed costs, or expenses that don't adjust regularly, can be a huge money saver during times of high inflation.
Most investors take out a mortgage to purchase a rental property, which is usually a 15- or 30-year fixed-rate note. The beauty of a rental property, of course, is that a tenant helps the property owner to pay back their debt over time. But having fixed-rate mortgage payments means that the property owner's debt amount will never increase, which helps to further reduce exposure to inflation.
Plus, since the dollar's buying power decreases with inflation, a stagnant $1,500 mortgage payment might feel like a lot less in the future.
How to hop on the rental trend
Rental real estate has garnered a lot of attention from investors lately, on scales small and large. A report from the National Association of Realtors (NAR) found that institutional investors purchased 13.2% of all homes in 2021. Higher investor participation, particularly from cash-heavy investment firms and real estate investment trusts (REITs) definitely makes it more challenging to get into the rental game. However, there are certainly still opportunities to invest.
Rising interest rates coupled with today's high home prices make it both less appealing and less affordable for new buyers to purchase a property. While the nationwide inventory of houses for sale is still recovering from the COVID-19 pandemic, the number of active listings is on the rise, up 18.7% compared to last June. This means that there's shrinking demand at a time when inventory is rising, leading to less competition and more buying options for investors.
And since inflation is nowhere near tamed, there is a good chance mortgage rates will continue to rise as the Federal Reserve increases interest rates. Locking in lower fixed-mortgage rates today further solidifies your chances of combating inflation while also benefiting from passive income potential today and home appreciation over a longer time horizon.
The key to doing this successfully is buying real estate in a high-demand market with ample job opportunities and low enough home prices to earn a positive cash flow. Major metro markets may be the first that come to mind when trying to check these boxes, but they are often met with high competition and prices. Instead, look for up-and-coming mid-tier markets. The mid-west and parts of the southeast are filled with high-demand rental areas with affordable home prices compared to neighboring metro markets. Low cash flow margins put you at risk in the event of a downturn in rental rates or prices and could leave you overleveraged. Always invest for cash flow first and keep the long-term benefits of owning rental real estate at the forefront of your strategy.