At a Glance —
- Rising inflation erodes bond values as well as stock prices
- Investors can find effective ways to hedge against inflation by adding smart real estate investments to their portfolios
- During times of inflation, equity on real estate increases while any fixed debt payments remain static
- When lease agreements are reset during times of inflation, the higher value of the real estate is taken into consideration, generating higher lease income
Inflation is part of our economic history.
There is absolutely no denying inflation today.
With food and energy prices increasing dramatically, investors must protect themselves against inflation and the loss of value due to rising prices.
But today’s inflation backdrop is not new. Throughout our history, there have been numerous periods of high inflation. Learn more in Dorothy Neufeld’s article, Visualizing the History of U.S. Inflation Over 100 Years.
Investment choice matters.
With bond investments, inflation can erode fixed-income products’ principal values. The purchasing power of the interest payments declines over time as inflation rises, making the bonds less valuable.
Stock market valuations often act in the same way, with investors discounting future cash flows at a higher rate when inflation rises, which pushes down the price investors are willing to pay for the stock.
Real estate investors benefit in multiple ways.
One reason real estate can act as a hedge against inflation is the effect of that inflation, on debt. As real estate prices rise over time, it lowers the loan to the value of any debt, acting as a natural discount. As a result, equity on the property increases while fixed debt payments remain static.
Inflation also benefits investors who earn income from rental properties. For example, a tenant pays rent to lease a building or property. That rent is income to the investor. Lease agreements typically reset pricing periodically. When the rental rates reset during times of inflation, rent increases based on the increased value of the underlying property. Some leases renew every few years, like industrial or retail properties. Other leases renew monthly, like apartments, and some even renew nightly, like hotels.
The more frequently you are presented with opportunities to adjust the rental rates, the better the hedge against inflation. Resetting rates allow the real estate property to capture the new higher-priced value and, in turn, result in a better return for the investor.
While not all aspects of inflation can be avoided, there are ways to hedge against inflation risk. Investing in real estate helps to increase the diversity of your portfolio and in many cases will increase the power of your investment dollar.