10 Reasons Real Estate Is a Smart Investment in an Inflationary Environment

It's no secret that inflation is red-hot these days. A combination of supply chain disruptions, labor shortages, and an increase in the money supply following several generous rounds of stimulus during the pandemic have led to consumer prices rising faster than they have in 40 years.

A number of categories are experiencing faster-than-normal inflation, and real estate is among them, with costs for "shelter" up 4.4% over February of last year.

Home prices have boomed over the last two years, and rents are soaring as well, making it a great time to be a real estate investor. Let's take a look at 10 reasons owning real estate is a smart move in an inflationary environment.

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When prices rise, not everyone loses. If you're selling the inflationary item, you benefit from rising prices. The same is true of ownership. There's typically a landlord and a tenant in a residential real estate relationship.

When prices rise because of increased demand or other reasons, the landlord benefits at the tenant's expense. Therefore, you're much better off being an owner than a renter during an inflationary period, as both the value of your property and the income you can generate from it grow.

ALSO READ: What Is Inflation?

Most homeowners and real estate investors use debt such as mortgages when buying real estate. Debt is a powerful tool in and of itself in real estate investing, but it becomes even more useful in a high-inflation environment.

That's because most homeowners use fixed mortgages to buy homes, locking in the mortgage rate. In a high-inflation environment, interest rates tend to rise as they're expected to now.

That means most mortgage holders are protected from the downside of rising inflation and interest rates while enjoying the benefits of rising home prices.

The mortgage also gives them a tool to leverage their investment, as they only have to put down a fraction of the cost of the home, making home-price growth even more valuable.

While rising rates may make it more expensive to borrow money, the increase in real estate value means you can borrow more against the value of your home or real estate investment in the form of a home equity loan or similar financing vehicle.

Now might be the best time to take advantage of such an opportunity because inflation has lifted real estate values significantly over the last two years, but the Federal Reserve still hasn't raised interest rates.

If you're considering taking out a home equity line of credit or another loan, you might be surprised at how much you're able to borrow.

ALSO READ: The Pros and Cons of a Home Equity Loan

Real estate has clear inherent value, unlike some assets like cryptocurrency or even stocks. After all, people need places to live, and businesses need space to operate in.

Real estate prices can be volatile based on other market factors, but the elasticity of real estate prices is relatively low compared to other asset classes. This is due to housing and other kinds of real estate generally being a need rather than a want.

Therefore, real estate is a good hedge against rising inflation and other economic risks.

Real estate investors typically make their income on rents, which are often directly tied to inflation. In fact, a number of cities and states have laws that tie the permitted increase in rents to the consumer price index (CPI), so the higher the growth in the CPI, the greater the rent increase often is.

Some commercial leases also have stipulations that tie rent hikes to increases in the CPI, which means rents go up more when the CPI is rising faster.

Finally, rising costs offer landlords cover for raising rents, especially if their own costs, like utilities and maintenance, are rising.

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Inflation typically raises construction costs, which is a detriment to some real estate investors, especially builders and those working in new construction.

However, if you already own real estate, then new supply coming on the market is generally a bad thing. After all, real estate prices are primarily driven by the relationship between supply and demand, so limiting supply through higher costs for construction or borrowing rates raises the value of the existing real estate supply.

ALSO READ: Will Home Prices Stay Inflated in 2022?

Another important feature of real estate is that it tends to be uncorrelated with other asset classes like stocks, bonds, and cryptocurrency.

That's important because prices for stocks, bonds, and crypto tend to fall in an inflationary environment, though bond yields rise. And market activity this year has been a reminder of that as prices in those asset classes have all declined.

On the other hand, real estate prices generally go up with inflation as housing is a real good connected to the rest of the economy, subject to the same forces of supply and demand.

A recent study by a group of Stanford economists found that during the high-inflation period in the 1970s, known as the Great Inflation, home prices grew faster than the size of the overall economy, while stocks and bonds underperformed.

Real estate, in part, benefits from the perception that it is generally inflation-proof. There has only been one sustained national decline in housing prices -- during the great financial crisis -- so most investors believe real estate is a relatively safe place to park your money, especially compared to stocks and crypto.

ALSO READ: Housing Supply and Demand in 2022: What to Expect

Prices aren't the only thing that goes up in an inflationary environment; wages tend to rise as well. And that's good news for real estate investors as it gives prospective tenants and homebuyers more money to spend, bolstering real estate.

In the current economy, a number of data points show wages are increasing as average wages are up 5.7% over the last year, according to the Bureau of Labor Statistics.

Rising prices and rising wages create a cycle in which inflation is likely to continue until something interrupts it, and that pattern is beneficial for real estate investors.

Fears of rising prices have had an odd effect on the housing market. While some potential homebuyers have decided to sit out the market in hopes that prices cool off, others have decided to jump into the market before prices rise even more, a phenomenon some have called "panic buying."

With mortgage rates now rising and expected to do so at least through this year, housing demand is likely to remain strong as prospective homebuyers seek to lock in mortgage rates while they're still relatively low.

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Real estate investing spans several classes -- from residential to commercial to industrial -- which are broken into segments like retail, office, multi-family housing, and single-family housing.

Investors looking to ride out inflation should stick with residential real estate. Commercial and industrial real estate can be more sensitive to the overall economy than the residential sector as they're tied more to business expansion, and sectors like office real estate are particularly troubled by the remote work trend.

Even in residential real estate, the booming growth of the last two years will slow down eventually. However, the housing market looks poised to outperform other asset classes in the current environment and will benefit from inflation.

That's good news for real estate investors.