It’s certainly no secret that we are facing a historic period of inflation. While the prices of goods and services are soaring, many people are trying to find ways to hedge their finances against the long-term impacts of high inflation rates. Economists report that inflation rates have increased at their fastest rate since the inflation crisis of 1982, which has led many people to try to find ways to protect themselves financially.
In the same way that consumers are reeling from the impact of high inflation, investors are also feeling the crunch. Depending on the type of assets that an investor has chosen, they may be dealing with sharp declines in the value of those investments. Additionally, people who have invested in retirement accounts have noticed a sharp decrease in the value of those accounts, leaving older investors especially vulnerable, as their retirement accounts simply aren’t as valuable as they were only a couple years ago.
While some investment vehicles lose their viability in the face of soaring inflation, there are some options that savvy investors choose to rely on during these periods. Multifamily properties are wonderful tools against inflation. While there may not be a way to completely protect yourself from the negative impacts of inflation, there are steps that you can take to minimize the amount of damage that your portfolio suffers. Discover more about what you can expect from multifamily investments during periods of inflation like we’re currently facing.
What is Inflation?
In the broadest of economic terms, inflation is defined as the increase in price of consumer goods and services. If you take a more detailed, scientific approach, inflation is the decrease in the purchasing power of a single dollar. For example, a year ago, the price of a carton containing one dozen eggs has gone up 60% compared to where it was at last year. That means that if you paid $2.00 for a dozen eggs last year, you should expect to pay $3.20 for those same eggs this year. The $2.00 that you used last year are not as valuable today as they were then. This is because of inflation.
It’s also important to understand that there are different types of inflation. It’s easy to use the term “inflation” as an all-encompassing term, but different types of inflation have different impacts on the economy.
The first, and perhaps most common type of inflation is called cost-push inflation. Under this type of inflation, the costs of operating a business increases due to the cost of goods. When a business must pay more for the goods that they distribute, that cost is passed to the customer or client. One such example of this type of inflation is found at the gas pumps, where prices are soaring. When the gas station that you stop at must pay more for the gas in their tanks, they raise the price that you pay for gas in order to cover their added costs.
The second type of inflation is referred to as demand inflation. This type of inflation mirrors the laws of supply and demand, which are at the heart of the real estate industry. The price of certain goods goes up when the existing supply cannot keep up with the demand. In most cases, demand inflation happens during peak economic times when people have more discretionary income. In those times, people are willing to pay more for a good or service because they have access to more money.
Which Type of Inflation Impacts Multifamily Housing?
Multifamily real estate is one of the very few asset classes that can be impacted by both types of inflation. While this may not be great news for those who are looking for places to rent, it’s certainly a good thing for people who have invested in real estate.
Cost-push inflation directly impacts the ability of people to have a new home built, a topic that we will discuss at greater length in a moment. While this concept directly impacts the price of new constructions, the decrease in the value of a single dollar also makes it harder for people to get mortgages.
Additionally, demand inflation also has a positive impact on multifamily properties, since the laws of supply and demand are a staple in this example of inflation. When more money is flowing through the economy due to people having an influx of discretionary income, people who were not planning to sell their homes may find themselves doing so because of an offer that they received.
In the most recent real estate boom, it became common for people to start making offers on properties that were not formally listed on the market. While those people buying homes obviously weren’t looking for properties to rent, the people who were moving out of their homes unexpectedly did need to find quick housing options. This was great news for investors, especially those who were willing to negotiate shorter lease terms.
Why Multifamily Real Estate is a Good Hedge Against Inflation
For generations, savvy investors have relied on multifamily real estate to hedge their portfolios against inflation. There are several reasons for this, and before we get into how multifamily investments can benefit because of inflation, it’s important to understand why investors continue to choose multifamily properties as their chosen method of battling inflation.
First of all, everyone needs somewhere to live. When you’re considering the basic elements of human survival, shelter is at or near the top of the list. When inflation rates go up, it becomes significantly harder for people to obtain the mortgages that they need to purchase a home. Even though the demand for housing never goes away, the ability for potential buyers to obtain mortgages does. This leads to people needing to rent a place to live, which is great news for people who have invested in multifamily properties.
Since more people look for rental properties when they can’t afford to get a mortgage, the principle of supply and demand leads to an increase in rental property values. While there are laws in place that prohibit price gouging and other aspects of multifamily investing, it is an undeniable truth that landlords can charge more for a rental property when there are more people interested in renting them. If you own an apartment complex that has 24 units and there are only 12 people interested in renting, you won’t be able to charge much in rent. However, if you have that same 24-unit apartment complex when there are 48 people looking for a place to rent, you can charge more in rent. Everything in the world of real estate goes back to the laws of supply and demand, and that is especially true during periods of economic uncertainty brought about by high inflation rates.
In the real estate industry, there are typically four groups of people: Homeowners, buyers, sellers, and renters. Investors fall under the heading of owners. When there are fewer buyers, it means that there are fewer sellers. This leaves homeowners (investors) and renters as the two primary groups within the industry. Buyers who aren’t in a position to get a mortgage at the time typically become renters, which is great news for investors who own their properties.
Making more money on your multifamily properties is only one part of the equation. Obviously, it’s a good thing if you can charge more money for the same unit. However, if you have used debt to leverage the funds that you needed to invest in a multifamily property, it’s worth noting that you will be paying your monthly mortgage payments with money that isn’t as valuable at the time. Remember, inflation is essentially the decrease in the value of a single dollar. When you repay your mortgage during periods of high inflation, you are paying down debt with deflated dollars. By the time the economy turns around and the dollar is worth more, you will have a large portion of the debt paid down, allowing you to be on better financial footing.
The mortgage lender that you used to obtain the funding for your investment doesn’t get to charge you more each month based on the current value of the dollar. That is to say that if your monthly payments were $2,500 when you agreed to the mortgage, you will owe that lender $2,500 per month going forward, even if that $2,500 doesn’t have the buying power that it had at the time of the initial agreement.
It’s also worth noting that the most successful investors are those who understand how to legally use the tax benefits that are made available to real estate investors while managing their portfolio. For instance, multifamily property investors can claim the depreciation of their property’s value on their taxes in addition to other legal write-offs. In periods of high inflation where the dollar decreases in value, saving as much money as possible is a great idea. This includes identifying legal opportunities to pay less in taxes.
Depending on the type of inflation that the economy is facing, the price of newly constructed homes may also become more than most people can take on at the moment. Within the mortgage industry, there are different types of mortgages. For instance, a borrower doesn’t need the same type of mortgage to purchase an existing home as he or she would need to use to pay for the price of a new construction. In periods of cost-push inflation, the construction industry suffers.
The price of lumber and other building materials typically soar during periods of cost-push inflation, which makes it much more difficult for people to afford to have new homes built. Most contractors and home builders set the price of their projects through a method known as “cost plus” pricing. These contractors typically take the cost of materials, multiply it by two, and that is the material cost that is passed along to the customer. When the price of those materials goes up for the contractor, the price will increase for the customer, as well.
There are also time considerations that must be made when looking for investment opportunities. This is especially true if you are considering investing in real estate. Many people assume that real estate investing is a time-consuming proposition, but that’s not necessarily the case. There are several options for investors who want to invest in multifamily real estate, many of which don’t require you to be a landlord.
Is Multifamily Real Estate Right for Me?
Obviously, there is no way to determine when this period of high inflation is going to go away. Unfortunately, many economists who specialize in formulating financial projections believe that things aren’t going to get better in the coming year. Obviously, there is always room for things to change, but there is currently no reason to expect inflation rates to return to normal in the immediate future. With that in mind, investing in multifamily real estate is a great way to hedge yourself against some of the negative impacts of high inflation. The ability to invest in an asset class that depends heavily on supply and demand during a time when many people are looking for a place to rent makes multifamily real estate one of the most inflation-proof investment options that there are.