There's been a lot of talk and speculation in the news lately about U.S. monetary policy. While inflation has come down significantly, many businesses, consumers, and investors have borne the brunt of a volatile environment. While no one can be certain what the future will bring, it's wise for educated real estate investors to understand how real estate inflation works, how a high inflation market can affect your assets or debt, and the best way to hedge against inflation.
Before the COVID-19 pandemic, the average rate of inflation in the United States was 1.8%. In 2020, the annual inflation rate in the U.S. fell to a mere 1.2% as demand across sectors sunk. Shuttered businesses, people out of work, and large injections of stimulus money from the federal government then set the stage for an unprecedented scenario.
As the economy re-opened, various factors ranging from an increased influx of cash for consumers to shifting consumer sentiment and demand recovery coupled with a shortage caused by supply chain disruptions led to inflation spikes.
The annual U.S. inflation rate reached 8% in 2022. Over the last few years, aggressive moves from the Federal Reserve to curb inflation in the form of escalating interest rates have affected a myriad of sectors, including the real estate space. High interest rates have driven up the cost of financing and mortgage rates while driving property values higher.
The central bank enacted its first major rate cut since the pandemic in September 2024, cutting interest rates by a half-point, and lowering the federal funds rate to a range between 4.75% and 5%. More rate cuts are expected, although some analysts think the Fed could be getting very close to its 2% overall target.
Whether the U.S. sees near-normal rates of inflation soon or still elevated ones resulting from these distortions in the normal economy remains to be seen. Regardless of the current economics, there are things real estate investors can do to hedge against inflation so their real estate portfolio thrives.
What is inflation?
What is inflation?
Inflation is an average increase in the prices for a collection of goods and services in a given economy over a set period of time, usually calculated by year. Essentially, it's the decrease in the purchasing power of the dollar over time. When you add costs up for all your purchases, including groceries, gas, phone bills, massages, etc., over the past year, you'll likely have a much higher number and higher cost for goods than you did a few years ago. That being said, inflation has different effects on different sectors.
Real estate investors can profit in times of inflation due to the increase in the value of these tangible assets. Real estate values also tend to be very market-specific and consumer-driven by supply/demand factors, although the increased cost of funding real estate purchases due to inflation can decrease transactions.
It's important to note that inflation is not appreciation. An appreciation rate, as it relates to real estate, is the increase of a property's value over time. With appreciation, value does not increase in relation to the currency; it increases based on demand. You can have scenarios where a home appreciates more than the inflation rate, and alternatively, you can have it depreciate in an inflationary economy.
Effects on real estate
How does it affect real estate?
Potential upsides during times of high inflation are rising prices for rental property rates. During high inflationary times, it can be difficult to get a mortgage. High mortgage rates mean buyers have less purchasing power, so many continue to rent. The surge in demand results in increased rental rates, which is great for landlords. And while appreciation is a distinct and separate market analysis, housing prices tend to rise in an inflationary economy. Real estate has intrinsic value; people need to have roofs over their heads regardless of the value of their currency. If you're able to offer favorable terms for private mortgages, you'll likely have a line out the door.
Downsides for a real estate investor in inflationary times include the increased cost of borrowing debt. To make sure the bank doesn't lose money, they'll charge higher interest rates and offer fewer loans. Increasing costs of building materials for new homes is another disadvantage. Between the high cost of borrowing and the additional cost of building, new construction can be a very difficult investment during inflation. When pockets get tight, travel usually gets cut from the budget pretty quickly. Vacation rentals, locations that are driven by tourism, or retirement communities may not fare as well as other forms of real estate investing.
Related investing topics
Wise investments
Wise investments for an inflationary economy
Investing in real estate is always highly dependent on the market and location of the property. But speaking generally, the following real estate investments fare better than others in a high inflationary economy:
- Rental properties, including residential, commercial, multiunit, and single-family homes, will likely have higher-than-normal demand and returns.
- Note investing: Banks may be offloading notes in higher-than-normal quantities, which will result in less competition and lower prices.
- Real estate investment trusts (REIT) will follow the market demands and appreciation similar to that of physical real estate and can be a good way to distribute your investment across a large number of assets.
Having funds available to seize an opportunity when it arises will be critical. Inflation can affect real estate investing both positively and negatively depending on the type of investment, the specific market, and various other factors. For example, lower note prices may not be worth it if defaults are at an all-time high. Make sure to do your due diligence, as with any sound investing, and consult with a real estate professional to identify promising options for your market.
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