The Effects of Inflation for the Real Estate Investor
Just like any other investment, inflation plays a critical role and the effects and the returns that a real estate investment can generate. Is critical that a real estate investor understands and acknowledges these effects when evaluating their existing portfolio we're looking to expand it. Let's examine both the positive effects and negative effects that inflation can play in your real estate Investments.
What is Inflation?
Inflation is the effect of more money in the economy chasing a limited supply of goods and services. Thereby making a larger demand for goods and services, which drives prices higher. Currently inflationary pressures are being caused by a pumping of money into the economy by the government and a lack of goods and services fueled by the several year pandemic effects. Additionally, the federal reserve, which acts to control monetary policy, has allowed costs of capital to remain low for an extended period of time, further exacerbating money supply creation.
Positive Effects of Inflation on Real Estate Investments
Increase in Rental Rates: While some commercial real estate leases allow landlords to increase rents to tenants, most residential real estate leases are short term leases that allow landlords to request increases on renewal dates.
Increase in Selling Prices: Historically, housing prices have increased with the increase of inflation. Eventually, higher and higher inflation will make lending and housing affordability more expensive for retail buyers and reduce the demand for housing. This can be an advantage to landlords who will have a larger market pool of renters.
Real Estate as a Hedge Against Inflation: Real estate investments can provide a good hedge against inflation. Putting money into investment real estate instead of savings when inflation is outpacing savings or money market accounts or risky volatile stock market fluctuations can be a wise decision. Long term fixed rate debt allows an investor to lock in low interest financing against an increasing rate of inflation. Riding a wave of higher valuations for your real estate can be one way to safely hedge against inflation risk.
Negative Effects of Inflation on Real Estate Investments
Higher Costs of Acquiring and Financing Investment Properties: During inflationary periods, commercial lenders will raise their costs to borrowers. Since many local and regional lenders are the primary source of capital for real estate investors, they will be forced to pay their depository accounts a higher rate of interest for their deposits. This will increase the required rate of return for the banks on their lending portfolio. In other words, the cost for financing for real estate investors will increase during inflationary periods.
Higher Costs of Operating Expenses: Most all costs associated with the economy will likely increase during inflationary periods. Real estate investment operating costs such as utilities, supplies, insurance, and property taxes will most likely increase. The cost of these items may increase 3-10% more in a period of inflation. If the real estate investor is unable to “pass” these costs on to the tenants in the form of higher rents, then it will provide a negative impact on the net operating income (NOI) for the property.
Higher Costs of Construction for New Buildings or Renovations: Increased demand for goods and services relating to building supplies will lead to increased costs for the developer or renovator. These increased costs will have to be pushed through the tenants in the form of higher rents. This will eventually result in lower construction starts and lower inventory levels in the marketplace.
Good or Bad?
In general, inflation is more of an advantage than a disadvantage for real estate investors. Unless you own investment property that is directly linked to inflationary casualties, then you can generally expect to ride the wave up with higher rents, and property values. Having fixed rate financings in place will also allow you to take advantage of positive leverage impact with respect to the long term debt financing.
Aegis Realty Partners works with our management clients to help them navigate the real estate investment market and come up with competitive strategies to increase their cash flow and reduce their operating costs.
Aegis Realty Partners Real Estate Investment specialists are well positioned to advise our investors to seek out new real estate acquisitions as well as assist real estate investors when it comes to selling their properties.
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