This pandemic showed us just how rapidly the market can swing. Unexpected highs and staggering lows have jolted brokerage and retirement accounts. While there is no way to tell exactly what the economic damage from the global COVID-19 novel coronavirus pandemic will be, there is widespread agreement among economists that it will have a severe negative impact on the global economy.
But, let’s remember, the broader global economy and your personal economy do not have to move in lock step. While everything is seemingly on hold or falling, the time is now to think level headed about our financial livelihoods. Smart investors will retreat to tangible assets that hold value – especially in inflationary environments.
Why? Real assets have what’s known as an intrinsic value. It is the value people attribute to them for their direct or indirect usefulness. Examples include commodities (wheat, sugar, etc), gold, real estate, productive land, etc. In general, real assets hedge better than paper assets. By definition, real assets have a value of their own. Inflation does not erode the value of real assets, instead any income produced from assets rises or falls to match the inflation rate. Therefore, real assets can be an inflation hedge. It follows that real estate is also a hedge.
Tangible assets like real estate property have historically been seen as inflation and deflation hedges. Real estate in particular fairs well in a variety of environments, and particularly when it comes to volatility, it comes up with inflation and with minimum risk of deflation.
But how do we profit from inflation in real estate? Inflation is defined as a general increase in prices and fall in the purchasing value of money. This means that each dollar buys less and less in an inflationary environment. Think of it like this: in normal terms, let’s assume that a tank of gas costs $20. In an inflationary environment, that same tank of gas may cost $25. The gas did not change. The distance you can drive did not change. But the amount of money you had to spend did. In effect, your buying power decreased.
Real estate can beat inflation not only because of its rising prices increase the resale value of the property over time, but because real estate can also be used to generate rental income. Just as the value of the property rises with inflation, the amount tenants pay in rent can also increase over time. This increase lets the owner generate income through an investment property and helps them keep pace with the general rise in prices across the economy. This means that as inflation rises, the property owner’s income rises to an equivalent degree – preventing any loss of buying power.
This, in essence, is what makes rental real estate so valuable regardless of the broader economy.
But how does real estate do in real terms?
Prior to the pandemic, home prices have appreciated nationally at an average annual rate between 3 and 5 percent, depending on the index used for the calculation. And, home value appreciation occurs at markedly different rates in different metro areas. There are factors to consider for the appreciation of real estate and this includes:
The supply and demand dynamics of a particular location – When there is an increasing demand for homes in a certain area, property prices go up if the available product for purchase does not meet the demand and homes are not built fast enough. In other words, people buying homes for their own use (end-users) are willing to pay more for a home because living in that area is attractive and desirable.
On the rental side of supply and demand, when there are more willing tenants at a price point than available properties, demand will be high, vacancy rates decrease and rent prices increase. Also, depending on the class of rental, even in recessionary times, certain price points experience an increase in demand as people look to reduce living expenses.
Rental real estate is the most accurate valuation of the market because the buying window is short making pricing feedback much more real-time than the buy/sell side. The development of new infrastructure or other amenities such as schools, shopping malls, airports, or access to public transport allow a particular area to maintain attractiveness throughout market cycles.
These are all great from a fixed-value standpoint. Income producing real estate, in essence, unlocks the full value of a property by turning it into a revenue-generating system.
Depending on the market, the average real estate market growth can be higher than the inflation rate. Investing in income-producing real estate not only hedges your revenue against inflation, you have a strong change of beating it and covering your losses with long-term capital growth. Furthermore, when you invest in rental properties you also get monthly rental yield as passive income.
In uncertain times, it makes sense to diversify into tangible assets proven to perform in economic environments like this. Your primary financial goal should be to retain buying power and increase your capital faster than the current inflation rate. It’s also important to control the risk of your investment and ensure to place your money on assets that appreciate over time.
Housing Joint Venture is a real estate investment and education firm. We teach professionals a proven, step-by-step approach to growing their own, independent income stream with real estate.