Former president Ronald Reagan once remarked, “Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man.” While there’s a fair amount of hyperbole in that statement, the comparison of inflation to a robber is an apt one. As a market force, inflation can and will devalue your investments. Fortunately, investors have a powerful tool to restore some balance.
What exactly is inflation? The simple definition of inflation is “a general increase in prices and a fall in the purchasing power of money.” The rate of inflation is measured by the Consumer Price Index and reflects the average change over time in the prices paid by consumers for goods and services. There are three things that lead to inflation:
The housing market, like all other economic sectors, is impacted by inflation. If there’s a reduction in the available inventory or an increase in demand, prices will go up, as we’ve seen. The price of a house can rise because the actual structure itself may be worth more due to rising lumber costs, but also because people see value in it as an investment.
How to Outperform Inflation
If you were to take your money and leave it in a savings account, you wouldn’t even get a one percent return. Simultaneously, the rate of inflation between April 2021 and April 2022 was 8.3%. Your money would actually lose its purchasing power by sitting in a savings account.
An excellent way to combat inflation is through real estate investing, especially in the rental property market. Even with high inflation, real estate still appreciated well above the general rate of inflation in the past year. While that year-over-year increase in asking rents and home prices could be an anomaly, the demand for rental housing clearly is not. In a study earlier this year, mortgage-finance company Freddie Mac estimated that the national deficit of single-family homes stood at 3.8 million units at the end of 2020. While that shortfall could eventually be made up for, that’s not likely to happen soon. In the meantime, a lot of would-be homeowners will remain in the rental market.
Even if you were to finance your rental property, you’d still be better off financing a rental property than putting your money into a savings account. It sounds counterintuitive, but your debt would be fixed while the rent you could charge would increase with inflation. With tenants paying off your loan, you’d be able to capture the benefits of inflation, both in the rent you could charge, and when you eventually sell your property.
While we don’t know how long we’ll be facing high inflation, investment properties will hedge against inflation for as long as you own them.